Week 2 - Financial Markets 1 Flashcards
How do you calculate the interest rate of a bond?
i = (FV-P) / P
What is the relationship between bond price and interest rate?
The higher the bond price, the lower interest rate
The higher the interest rate, lower the bond price today
When is the financial market in equilibrium?
Ms = Md = M
money supply = money demand
How does a central bank conduct expansionary open market operation?
The central bank increases the supply of money by buying bonds
How does a central bank conduct contractionary open market operation?
The central bank decreases the money supply by selling bonds
What is the equation for money demand (Md)?
Money demand (Md):
Md = $YL(i)
$Y = level of transactions in economy
L(i) = decreasing function of the interest rate
What happens for the demand for bonds and demand for money when interest rates increase?
Demand for money decreases
Demand for bonds increases
What happens when money supply increases?
MS curve shifts outwards
=>interest rate decreases
=> demand for bonds decrease
=> demand for money increases
What happens when nominal income increases?
Md curve shifts ouwards
=> interest rates increases
=> demand for bonds increase
=> demand for money decreases
What are the assets and liabilities of a central banks balance sheet
Central banks:
assets = bonds held
Liabilities = Money in economy
What are the assets and liabilities of commercial banks?
Commercial banks:
assets = Reserves + loans + bonds
liabilities = Checkable deposits
What happens to high-power money supply when a central bank uses expansionary open market operations?
CB buys bonds
=> Hs supply increases
= > Ms increases
=> interest rate decreases
What is the liquidity trap?
Zero lower bound:
When interest rates hit 0, monetary policy cannot improve economy
md curve is horizontal
People become indifferent between money and bonds
