Week 5 Flashcards
Why are determinants of interest rates important?
- Interest rate movements have a direct influence on the market
values of debt securities, such as money market securities,
bonds, and mortgages. - They also have an indirect influence on equity security values
because they can affect the return by investors who invest in equity securities. - Since many financial institutions invest in securities (such as
bonds), the market value of their investments is affected by
interest rate movements.
What are assets?
An asset is a piece of property that stores value: i.e. money,
securities (bonds, stocks), art, land, houses, equipment, and
manufacturing machinery
What are the facts when deciding to hold an asset?
- Wealth, the total resources owned by the individual, including all assets
- Expected return (the return expected over the next period)
on one asset relative to alternative assets - Risk (the degree of uncertainty associated with the return) on
one asset relative to alternative assets - Liquidity (the ease and speed with which an asset can be
turned into cash) relative to alternative assets
Why is wealth a determinant of an asset demand?
-When our wealth has increased, we have more resources available to purchase assets and the quantity of assets we demand increases
- Exceptions are inferior goods (the quantity demanded does not increase with the increase in wealth): i.e. McDonald’s coffee
vs Starbucks coffee
- an increase in wealth raises the quantity demanded of an
asset, Holding everything else constant
Why is expected returns a determinant of an asset demand?
-Expected returns
- the return on an asset (such as a bond) measures how much
we gain from holding that asset
- a decision to buy an asset is influenced by what we expect the return on that asset to be
-an increase in an asset’s expected return relative to that of an alternative asset, holding everything else unchanged, raises the quantity demanded of the asset
Why is risk a determinant of an asset demand?
-The degree of risk of an asset’s returns also affects demand for
the asset
- It is usually measured by the standard deviation of returns
- It measures the amount of dispersion of an asset’s returns
- Also it tells us about the probability of incurring large losses
Why is liquidity a determinant of an asset demand?
-Liquidity refers to how quickly it can be converted into cash
at low cost
- An asset is liquid if the market in which it is traded has depth
and breadth
- Liquid assets example: treasury bills
- Illiquid asset example: real estate
What is theory of portfolio choice?
-The theory of portfolio choice, or Modern Portfolio Theory (MPT), suggests that investors can build portfolios that maximize return for a given level of risk by diversifying across different assets, aiming for an optimal mix that balances risk and reward.
What is market equilibrium?
-Market equilibrium occurs when the amount that people are willing to buy (demand) equals the amount that people are willing to sell (supply) at a given price
What is excess supply?
-Excess supply occurs when the amount that people are
willing to sell (supply) is greater than the amount people are
willing to buy (demand) at a given price
What is excess demand?
-Excess demand occurs when the amount that people are
willing to buy (demand) is greater than the amount that
people are willing to sell (supply) at a given price
What are changes in equilibrium interest rates?
-When quantity demanded or supplied changes as a result of a
change in the price of the bond (or, a change in the interest
rate), we have a movement along the demand/supply curve.
- A shift in the demand/supply curve occurs when the quantity
demanded or supplied changes at each given price (or interest
rate) of the bond in response to a change in some other
factors besides the bond’s price or interest rate
- When one of these factors changes, causing a shift in the
demand or supply curve, there will be a new equilibrium value
for the interest rate.
