slides04 - Demand and Supply for Financial Assets Mishkin...

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[Mishkin ch.5 - P.1] Demand and Supply for Financial Assets Mishkin ch.5: Bonds • Motivation: - Monetary policy works primarily by manipulating interest rates. - Interest rates are determined by the demand and supply for bonds. - Demand and supply for other financial assets are determined similarly. • Perspectives on the bond market: 1. Bonds as financial assets => Determinants of Asset Demand. • Bond demand affected by relative risk, relative liquidity, and wealth. • Asset pricing (Finance) issues. Instantaneous responses to news. 2. Saving and Borrowing => Real Factors. • Bond market matches savers and borrowers, affected by their behavior. • Macro issues: Real savings/investment. Takes time. 3. Liquidity Preference • View bonds as alternative to holding money. Affected by monetary changes. • Special issues: Flexible versus “sticky” prices. DEFER. • Application: Money & Interest Rates • Mishkin provides survey. Needs more analysis – Start reading the lecture notes.
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[Mishkin ch.5 - P.2] Perspective #1: Bonds as Financial Assets • General Finance Question: - What determines the demand for financial assets? 1. Expected return (+) 2. Risk (-) 3. Liquidity (+) 4. Wealth (+) - Applies to all financial assets. Bonds as example. • The Demand Curve for Bonds • Remember “ High price <=> Low yield ”. Implies downward sloping demand function. • Demand function shifts if bonds’ risk or liquidity change. • Demand is relative shifts if return, risk, or liquidity on other assets change. • Note: Bond market responds quickly to financial news, to any news relevant for determining the return, risk, or liquidity of bonds relative to other assets. • Time horizon: Instantaneous (within seconds).
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[Mishkin ch.5 - P.3] Demand for other financial assets Same arguments as for bonds: - Downward sloping, because “higher Price <=> lower expected return” logic applies to all financial assets, provided the asset’s payment stream remains unchanged. - Shifting down/left when risk increases. Shifting up/right when liquidity increases. Examples: Stocks, mutual funds, real estate, gold, investments abroad. • Similar for equity-type assets, except future payments are uncertain - New element: Unexpected new information about payments shift the demand curve • Example: Stock with expected value next year $100 - More demand now at $80 than at $90 => Downward sloping demand curve.
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