Nominal interest rate i money demand is negatively

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Nominal interest rate, ( i ) Money demand is negatively related to i Real output (or GDP), ( y ) Money demand is positively related to y Price level, ( P ) Money demand is positively related to P
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Interest rate (i) Money 0 Money Demand The nominal interest rate, i* is the opportunity cost of holding money
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Interest rate (i) Money 0 Money Demand The nominal interest rate, i* is the opportunity cost of holding money higher income, higher prices financial innovation
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39 interest rate (i) money 0 M D M S i *
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Goal of monetary policy: stabilisation of the business cycle (close output gaps), specifically inflation targeting (average 2-3% pa over the business cycle) RBA’s main policy tool is control of interest rates (the ‘cash rate’) Reserve Bank Board meets monthly decides whether to change cash rate. RBA uses ‘open market operations’ to influence the ‘cash rate’. Changes flow on to other interest rates. 40
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41 Nominal interest rate ( i* ) Money 0 Money Demand Money Supply i* M* Choice money (cash and bank deposits) which pay no/little interest or bonds (pay interest) i 1 i 2 How does i adjust to i* ?
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Test pool questions now available on Blackboard Test is 20 marks (20 % assessment) 30 minutes during tutorial time Different tutorial questions will have different tests Calculation questions will have different numbers You must sit test in your enrolled tutorial group Answer sheet provided, bring a calculator NO Supplementary exam ( illness or misadventure must fill in special consideration application on myunsw within 3 days)
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The yield or return on a financial asset is inversely related to the asset’s price. Bond Principal = amount that is originally borrowed on the bond Coupon payment = regular dollar payment of interest on the bond Coupon rate = Coupon Payment Principal
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Tanya purchases a two-year bond with a principal amount of $1000. It has a coupon rate of 5% per annum, so she will receive coupon payments of $50 at the end of year 1 and $50 at the end of year 2, plus her $1000 principal.
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Tanya wants to sell her bond at the end of year 1 after receiving her first coupon payment. How much can she expect to get if the prevailing interest rate is now 6%? How about 4%? If current interest rates on similar securities are 6%, her bond needs to return 6% too or no-one would buy it. The coupon rate and principal payout on the bond are given, so the only thing she can alter is the bond price. She would price the bond so that the principal the buyer pays will receive 6% and yet receive $1050 at maturity.
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At current interest rates of 6% the principal to earn 6% over the year and be paid is: $1050 = Bond price x 1.06; that is a bond price of $990.57. If current interest rates are 4%, the principal to earn 4% over the year and be paid is: $1050 = Bond price x 1.04; that is a bond price of $1010.
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