Ch5.docx - Ch5 Interest Rate Determination 1 2 3 4 Wealth...

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Ch5. Interest Rate Determination: 1. Wealth goes up- greater demand for assets because there’s more wealth to invest with 2. Risk goes up- the riskier the market seems, the less desire to purchase assets 3. Expected return up- asset demand goes up as well 4. Liquidity of an asset rises- asset demand increased because you can sell it quickly Four Factors Impacting Asset Demand: One Year Discount Bond: I=(FV-Pb)/Pb where, I=nominal interest rate or Yield to Maturity, FV= Face Value, Pb= Price of bond I= (1000-950)/950= .053 or 5.3% I= (1000-970)/970= .0309 or 3.09% I= (1000-900)/900= .1111 or 11.11% Bond supply is greater than bonds demanded= excess supply of bonds, bond price drops Bond price drops, interest rates increase. Bond demand is greater than bonds supplies= excess demand of bonds, bond price rises Recession (national income drops) = corporate profits down
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Unformatted text preview: When there’s an excess demand for bonds the price of the bond goes up while the interest rates fall Interest rates are procyclical: in recession interest rates fall, in recovery interest rates rise Money supply is a straight vertical line. Money demanded is downward sloping because it’s assumed money doesn’t pay interest Model assumes only two assets: money and bonds Two factors impacting money demand 1. Income level (income up, money demanded up) 2. Price level (prices up, money demanded up) Recovery= income up, money demanded up, curve shifts to the right, excess demand for money, excess supply of bonds, pb down, interest rates up Fed increases money supply= excess supply of money, excess demand of money, price increases, interest rate decreases,...
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