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103 Cards in this Set

  • Front
  • Back

i is..

inversely related to Pbonds

PV =

CF/(1+i)^n

CF =

stream of future cash payments

i =

yield to maturity

R =

C + Pt+1 - Pt/Pt




C/Pt + Pt+1 - Pt/Pt

R = (another)

ic + g

how much of an asset people will want to hold in their portfolios

Theory of Portfolio Choice

the total resources owned by the individual, including all assets

Wealth

Everything else held constant...

an increase in the wealth will increase the quantity demanded of an asset

Two points for wealth

stock


at a particular period in time

is the probability weighted average of all the possible returns of an asset

Expected returns

Investors want...

R to be big

E[R] =

Ra(Proba) + Rb(Probb)

All else held constant...

an increase in an asset's expected return relative to that of an alternative asset raises the quantity demanded of the asset

____ ______ affect the rate of return on bonds

Bond prices

Changes in the price of bonds...

affects bond buyers and sellers differently

an asset where the return is very uncertain

Risk

What is risk averse?

someone who stays away from risk

What is risk neutral

Indifferent about risk

What is risk lover?

someone who likes risks

Most people are...

risk averse

All else held constant...

an increase in the riskiness of an asset relative to other assets, its quantity demanded will decrease

What is liquidity?

how quickly and cheaply can we turn an asset into cash

The more liquid an asset is relative to an alternative asset, all else held constant...

the greater the quantity demanded

supply and demand of bonds are described in terms of stocks, not in terms of flows

Asset market approach

Each bond price is associated with...

a particular level of the interest rate

Bond prices and interest rates are...

inversely related so as a bond's price goes up, its interest rate falls

For one year discount bonds...

YTM = R

YTm

Yield to Maturity

R =

Rate of Return

Bond demand (3)

Investors (people who BUY bonds)


want a high R


want to buy bonds when their price is lower

Pbond went up...

rate of return and YTM went down

Bond Supply (6)

Borrowers Supply Bonds


The cost of borrowing is the interest rate


As Pbonds goes up, the interest rate goes down


Thus, the cost of borrowing goes down


Want to borro more because it is cheaper


Supply of bonds increases

Each bond price is associated with...

a set interest rate

All interest rates...

move together

Lenders...

demand bonds

Quantity Demanded (supplied) changes as a result of...

a change in the price (or the interest rate) (movement along the demand (supply) curve)

A change in demand (supply) occurs when the...

quantity demanded changes at ever possible price (interest rate) (a shift in the demand (supply) curve)

One point of Wealth

If we have an increase in our wealth, demand for bonds will increase, which is represented by Shifting Bd up and to the right

Wealth regarding Expansions

wealth is increasing; Bd increase (shifts upward and to the right)

Wealth regarding recessions

Wealth is decreasing; Bd decreases (shifts down and to the left)

What is the marginal propensity to save increases?

shifts up and to the right; Increase in Bd

What is MPS?

every dollar given to me, I will save the MPS of it.

Expected return for a one year discount bond and a one year holding period...

the expected return and the interest rate are identical

If maturity is greater than one year...

then interest rates and returns are not identical

Higher expected future interest rates _____ expected future returns for long-term bonds

lower

Higher expected future interest rates lower expected future returns for long-term bonds, I expect...

smaller capital gains or capital loss, so I won't buy the bonds

Three points for Higher expected future interest rates

shift the demand curve down and to the left


expect the price of the bond to be lower in the future


don't know what a future return will be, but I can expect something

g<0

capital loss

R =

C/Pt + Pt+1 - Pt/Pt

R = (another_

ic + g

C/Pt

Coupon payment/current bond price

Demand for bonds:


Who?


Slope?

the lenders "investors"


As the price of the bond goes up, quantity demanded goes down

Supply for bonds:


Who?


Slope?

Borrowers


As the price of a bond goes up, quantity supplied goes up

interest rate =

cost of borrowing

P3>P*


QD

Excess Supply (Surplus)

What happened with excess supply

Price will go down until we hit P*


interest rate increases until we hit i*

P2



Qs

Excess demand (shortage)

Three points for Excess demand

buyers bid the price up


Price increases until we hit equilibrium


interest decreases until we hit i* and P*

Over time..

the market will correct itself

Changing Qd or Qs is...

a movement along the demand (supply) curve

What changes Qd or Qs?

Only price

Anything else changing is...

a shifting of the entire curve

Increase in expected return on alternative assets...

that will lower the demand for bonds (Shift Bd down and to the left)

Increase in the expected rate of inflation...

physical assets; that will lower the demand for bonds and shifts Bd down and to the left

What does an expected rate of inflation regard?

physical assets like houses, land, etc. look more appealing

What two things are closely related?

risk and liquidity

What do we assume regarding risk?

Risk aversion

Factors that shift the demand for bonds:

wealth


expected returns


Risk


Liquidity

An increase in the riskiness of a bond will...

decrease the demand for bonds (shift down and to the left)

What is liquidity?

how quickly and cheaply an asset can be converted to cash

An increase in the liquidity of a bond will...

increase the demand for that bond

What is an example of something that can change the liquidity of a bond?

the brokerage fees

As risk rises...

liquidity decreases

Four Factors that shift the supply of bonds

expected profitability of investment opportunities


expected inflation


government budget deficits


Open Market-Operations

Why do borrowers supply bonds?

to raise funds for investment opportunities

what is the cost of borrowing?

The real interest rate

An increase in profitable investment opportunities will...

increase the supply of bonds (shifts down and to the right)

What happens in an expansion regarding expected profitability of Investment Opportunities?

increase supply (more investment opportunities)

What happens in a recession regarding expected profitability of Investment Opportunities?

decrease supply (less investment opportunities)

Real interest rate (r) =

i - pi(e)

An pi(e) increases...

real rate of interest goes down

If r decreases, this is...

good for borrowers, which will increase bond supply

What is a Federal Government Budget Deficit?

government spends a lot more money than they brought in

What is one point for Government Budget Deficits?

U.S. treasury issues bonds to finance deficit

Higher government deficit...

increase the supply of bonds

Why do treasury bills never default?

because they can just print more money or raise taxes

An increase in the inflation rate will cause the demand for bonds to...

decrease (shift left) and the supply of bonds to increase (shift right). This drives the price of bonds down and nominal interest rates up.

If pi(e) increases....then

Bs increases, P decreases, Quantity Increases (positively related)


Bd decreases, P decreases, Quantity decreases; negatively related

When are Open Market purchases done?

during recessions

What happens in an open-market purchase?

the fed purchases bonds from the public

Three points for Open-Market purchases

give you funds which increases the money supply


lowers interest rates


supply of bonds decrease (shifts bond curve up and to the left

One point for lower interest rates

encourages more spending

One point of supply of bonds decreases

P increases so interest rates fall

What are open market sales?

the fed sells bonds to the public

Three points for open market sales

supply of bonds increases


money supply goes down


Pbonds decreases, so interest rate rises

R =

C/Pt + Pt+1 - Pt/Pt

Demand is...

desirability

Supply is...

Availability

When demand increases...

Price increases and quantity increases

When demand decreases...

Price decreases and quantity decreases

When supply increases...

Price decreases and quantity increase

When supply decreases...

Price increases and quantity decreases