5 IntRateEqm

5 IntRateEqm - Equilibrium Behavior of Interest Rates Prof...

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Equilibrium Behavior of Interest Rates Prof. Irina A. Telyukova UBC Economics 345 Fall 2008
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2 Outline ± We study two alternative theories of how interest rates are determined in an economy: ± A theory of bond demand and supply ± A theory of money demand and supply
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3 I. Determinants of Asset Demand ± The following variables tend to influence the demand for assets: ± Wealth ± Expected (relative) returns on all assets ± Risk ± Liquidity
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4 Theory of Asset Demand ± Ceteris paribus, asset demand is ± positively related to wealth ± positively related to its returns relative to other assets ± negatively related to the relative riskiness of the asset ± positively related to the liquidity of the asset
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5 II. Supply and Demand of Bonds ± At the root of our analysis of the market for bonds will be the previously derived conclusion that bond prices and interest rates are negatively related – ± the higher the interest rate, the lower the price of the bond ± e.g. a 1-year discount bond has YTM i=F/P-1 ± This allows us to use standard supply-demand theory to characterize the market
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6 Bond Demand Curve ± As the price of a particular bond increases, the demand for this bond falls ± Because of negative price-interest relationship, we can also say that as the interest rate (YTM) on a particular bond increases, the demand for this bond rises ± This gives a standard negatively-sloped demand curve for bonds
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8 Bond Demand Curve Q - amount of bonds, $ BD P - price of bonds
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5 IntRateEqm - Equilibrium Behavior of Interest Rates Prof...

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