Lecture 6-Financial markets.pdf

Lecture 6-Financial markets.pdf - 30-Jan-18 MACROECONOMICS...

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30-Jan-18 1 MACROECONOMICS LECTURE 6 FINANCIAL MARKETS CONTENTS OF THE LECTURE 1. Bond prices and interest rates 2. The demand for money in a financial markets model 3. Interest rate determination CONTENTS OF THE LECTURE 1. Bond prices and interest rates 2. The demand for money in a financial markets model 3. Interest rate determination
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30-Jan-18 2 1. BOND PRICES AND INTEREST RATES Consider a one-year bond that promises a payment of $100 one year from now. Suppose that the current price of the bond is P B . If you buy the bond today and you hold it for one year, what is the rate of return on holding the bond? The rate of return, which reflects the interest rate ( i ) of the bond, is: 4 If P B =$90, the interest rate is 0.111 (or 11.1%). If P B =$99, the interest rate is 0.010 (or 1%). Hence, the higher the price of the bond, the lower the interest rate . 1 $ 100 $ $ $ 100 $ B B B P P P i 1. BOND PRICES AND INTEREST RATES If we are given the interest rate, we can figure out the price of the bond using the same formula: 5 Hence, the higher the interest rate, the lower the price of the bond today .
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