Lecture_6_complete_version

Lecture_6_complete_version - Lecture 6 The Reserve Bank and...

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1 Lecture 6 The Reserve Bank and the Economy
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2 The Demand for Money Proposition : Given the demand for money by the public, the RBA’s control of interest rates determines the amount of money it can supply. Portfolio allocation decision Risk vs return vs liquidity Diversify risk Some assets provide services
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3 Money D and S Cash holdings influenced by: Financial innovation Economic growth Opportunity cost (i.e. yield) Thus demand for money is influenced by: The nominal interest rate (i) The price level (P) Money supply is determined by the RBA’s open market operations .
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4 Money Market equilibrium i M MD 0 MS M 0 i 0 MD 1 i 1
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5 Bonds A legal promise to repay a debt: principal + interest payments. Issued by governments Issued by firms The coupon rate : rate at time bond issued. Coupon payment (if annual) = principal x coupon rate Term : 24hrs – 30 years yield curve Sold to savers
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6 Source: CNNfn.com US 10-yr bond yields
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7 The Yield Curve
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Bond Prices and Interest Rates Bonds can be sold before maturity. Bond prices and interest rates are inversely related … why? Example: A 5 year bond, with a principal amount of 1000 and with a 5% coupon rate, paid annually, is bought on Jan 1, 2010.
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Lecture_6_complete_version - Lecture 6 The Reserve Bank and...

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