Monetary aggregates : measures of the money supply-M1 : most liquid assets (currency, checking acct deposits, travelers checks)-M2 : M1 + money market deposit accounts and money market mutual funds Ch. 4 // Understanding Interest Rates Cash flows : different streams of cash payments to the holder Present value : a dollar paid one year from now is less valuable than a dollar paid to you today The yield to maturity, which is the measure most accurately reflecting the interest rate, is the interest rate that equates the present value of future payments of a debt instrument with its value today. Application of this principle reveals that bond prices and interest rates are negatively related. When the interest rate rises, the price of the bond must fall, and vice versa. The return on a security, which tells you how well you have done by holding this security over a stated period of time, can differ substantially from the interest rate as measured by the yield to maturity. Long-term bond prices have substantial fluctuations when interest rates change and thus bear interest-rate risk. The resulting capital gains and losses can be large, which is why long-term bonds are not considered safe assets with a sure return. The real interest rate is defined as the nominal interest rate minus the expected rate of inflation. This is both a better measure of the incentives to borrow and lend and a more accurate indicator of the tightness of credit market conditions that is the nominal interest rate.
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