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Lecture_3-1

# Lecture_3-1 - Lecture 3 Principles of Macroeconomics Econ 2...

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Lecture 3 Principles of Macroeconomics Econ 2 Winter, 2009

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Every Breath You Take http://www. youtube .com/watch? v=ipJTqCbETog
Basis Points Interest rate changes are usually described using basis points A basis point is one-hundredth of a percentage point A 50 basis point cut in an interest rate is a ½ percent

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Basis Points Example: FOMC announcement
Yield Curve

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Yield Curve Dynamic Yield Curve
Yield Curve Yield curve spread: 10 yr. treasury bond – 3 month t-bill Or, 30 yr. – 3 month Typically the spread is positive If negative: an inverted yield curve

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A Quick Tutorial on Bonds
Bonds Bond • A legal promise to repay a debt, usually including both the principal amount and regular interest payments

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Bonds Principal Amount • The amount originally lent Maturation Date • The date at which the principal will be repaid
Bonds Coupon Rate • The interest rate promised when a bond is issued Coupon Payments • Regular interest payments made to the bondholder

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Bonds Bonds -- An Example • Principle amount of a bond = \$1,000 • Maturation date = January 1, 2025 • Coupon rate = 5% • Annual coupon payment = (0.05)(\$1,000) = \$50
Bonds Corporations and governments sell bonds to raise funds. The longer the term of the bond the higher the coupon rate.

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Bonds The greater the risk of default, the higher the coupon rate. Municipal bonds are exempt from federal taxes and have a lower coupon rate. Bondholders may sell their bonds at any time in the bond market at their market price.
Bonds Example • Bond prices and interest rates • Jan 1, 2006 purchase a 2 year government bond –Principle amount = \$1,000 –Coupon rate = 0.05 –Coupon payment = \$1,000 x 0.05 = \$50 (Jan 1, 2007) –At maturity: \$1,000 + \$50 = \$1,050 (Jan 1, 2008)

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Bonds Example Bond prices and interest rates Want to sell the bond on Jan 1, 2007 The prevailing interest rate = 6% Bond price x 1.06 = \$1,050 Bond price = \$1,050/1.06 = \$991 The prevailing interest rate = 4% Bond price = \$1,050/1.04 = \$1,010 • Observation Bond prices and interest rates are inversely related
Creating Economic Aggregates Important to distinguish between real and nominal values How might we think of adding together different goods we purchase?

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Creating Economic Aggregates How might we think of adding together different goods we purchase? We could “weight” each good by some value Use pounds, dollars, etc.
Creating Economic Aggregates We could “weight” each good by some value Use pounds, dollars, etc. The result is a quantity index The quantities are indexed or weighted by their contribution in pounds or dollars

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The Weight of GDP Greenspan: “The physical weight of our gross domestic product is evidently only modestly higher than it was 50 or 100 years ago.” Source: WSJ, May 20, 1999
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