(BBA)CH5 Behavior of Interest Rate

(BBA)CH5 Behavior of Interest Rate - Chapter Five The...

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Unformatted text preview: Chapter Five The Behavior of Interest Rate Supply and Demand Model for Bonds (p.91) Price of bonds D S P * Q * Quantity of bonds Determinants of Asset Demand (p.91) Why one person decide to buy and hold an assets, they must consider the following factors. 1. Wealth, total resources owned by the individual. 2. Expected Returns on one asset relative to another asset 3. Risk on one asset relative to another asset 4. Liquidity on one asset relative to another asset Responses of the Quantity of an Assets Demanded to Changes in Factors (p.92-93) 1. Wealth ( ) ; Quantity Demanded ( ) ↗ ↗ 2. Expected Return relative to other assets ( ) ; ↗ Quantity Demanded ( ) ↗ 3. Risk relative to other assets ( ) ; Quantity ↗ Demanded ( ↘ ) 4. Liquidity relative to other assets ( ) ; Quantity ↗ Demanded ( ) ↗ Theory of Asset Demand (p.93) Wealth Expected Returns Liquidity Risk Quantity of An Asset Positive Negative Demand Curve (p.94) The return on bonds is equal to interest rate measured by the yield to maturity. i = interest rate = yield to maturity = expected return F = face value of discount bond P = initial purchase price of discount bond P P F R i c- = = c R Demand Curve (p.94) If the bond sells for $950, the interest rate and expected return are ($1,000-$950) / $950 = 5.3%. Quantity of bond demanded is $100 million. At a price of $900, the interest rate and expected return are ($1,000-$900) / $900 = 11.1%. Quantity of bond demanded is $200 million. If the bond sells for $750, the interest rate and expected return are ($1,000-$750) / $750 = 33.3% Quantity of bond demanded is $500 million. Supply Curve (p.95) As bond price is $750 ( interest rate = 33.3%), quantity of bonds supplied is $100 million. At a price of $900, (interest rate = 11.1%), quantity of bonds supplied is $400 million. If the bond sells for $950, (interest rate = 5.3%). quantity of bonds supplied is $500 million. Supply and Demand in the Bond Market (p.95) At lower prices (higher interest rates), ceteris paribus, the quantity demanded of bonds is higher : An inverse relationship between price and quantity of bond. At lower prices (higher interest rates), ceteris paribus, the quantity supplied of bonds is lower : A positive relationship between price and quantity of bond. Supply and Demand for Bonds (p.95) Excess Supply Excess Demand Market Equilibrium P(p.96) The asset market approach for understanding behavior in financial market which focuses on stock of assets....
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This note was uploaded on 11/07/2010 for the course BBA 4565 taught by Professor Chushunhe during the Spring '10 term at University of Macau.

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(BBA)CH5 Behavior of Interest Rate - Chapter Five The...

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