State Oregon University Department of Economics
McMullen Fall 2007
Economics 330 - Review Sheet #1 Key Concepts/Definitions: *Money supply: M1, M2, M3- pg 33 The Federal Reserve vs US Treasury? *Liquidity- 26 *Primary vs. Secondary financial markets- 47-48 *full bodied money/commodity/fiat money- pg 28 Direct vs. indirect finance *Compounding*Present value- 97-98 *Financial instruments- 45-47 *Financial intermediary- pg 45 *Real vs. Nominal interest rates-436-437 *Term structure of interest rates/expectations theory *Capital gains/losses- 50? Interest rates and bond prices- 8,95,97/531-532 Loanable funds market- 99-103 *Federal funds rate- pg 53 Supply and demand for securities Prime interest rate *Default risk/junk bonds- pg 46/141 Ricardian Equivalence- 112 *Risk premium- 141 portfolio/diversification *Government securities: bills, notes, bonds Federal Reserve discount rate *barter economy- pg 20 *Commercial paper- 51-52 *current yield- pg46 Debt vs equity securities- pg 47 Expectations, liquidity premium, and segmented markets explanation for the term structure Of interest rates *The Fischer Effect- 105 *Stock risk vs. bond risk- 157-59/13 Loanable funds market The bond market- 13-14 The market for foreign exchange- 14-15/ 176-177 Exchange rates- 179-80 Interest rates and investment- 456? 81-84 The relationship between the stock market and investment/consumption 1. What are the basic functions that something must possess if it is to effectively serve as money? Page 19 2. What are the advantages to a small saver (such as you or I?) in buying shares in a money market mutual fund or putting money in a certificate of deposit relative to conducting our own individual transactions in the money market? Because these pull funds and get higher interest rates. And they are very liquid and can be removed at any time 3. If current market interest rates rise, what will happen to bonds prices? They will go down 4. If is there a recession, what will this do to: NOTES a) The demand for bonds. b) The supply of bonds. c) The overall level of interest rates. d) The risk premium between risky and risk-free bond Explain 5. If the Federal Reserve purchases bonds in the open market, what wll this do to: a) Bond prices.
b) Interest rates c) The government deficit. In addition to items on this review sheet, please review quizzes and homework.
The return to investors on stocks have two components: Dividends and Capital gains R = Dividends +/- Capital Gain or Loss Price Fisher hypothesis A rise in the expected inflation rates leads to a rise in the nominal interest rate, while expected real interest rates remain the same Anticipated inflation affects the prices of goods, as well as the number of dollars a security pays, but not any inflation-adjusted amount That is, dollar payments adjust to the same change in the inflation rate Example: If inflation is 4% instead of 3%, all dollar payments will compensate by being 1% higher PV = 1000/(1+i)n
r
1000 P 360 x 1000 days to maturity 1000(r )(days to maturity) P 1000 360
Money serves as a medium of exchange or means of payment standard of value or unit of account - store of value
Should The Federal Reserve React To Perceived Bubbles In Asset Markets? Arguments in Favor of Fed Intervention Excessive increases in asset prices (stocks and real estate) lead to economic instability. Excessive borrowing results from inflated collateral values. When the bubble bursts insolvencies ensue. The Fed should use the traditional benchmark measures of valuation and use monetary policy to dampen "irrational exuberance." Arguments Against Fed Intervention It is unrealistic to expect the Fed to reliably identify asset price bubbles as they develop. The Fed's responsibility is conducting monetary policy, not to manage asset prices. The Fed may do more damage than good.