The Behavior of Interest Rates & Bond Markets

Flashcards on Interest Rates & Bond Markets

Asset

Anything that can be owned and has value.

Wealth

The total resources owned by the individual, including all assets.

Expected Return

The return expected over the next period on one asset relative to alternative assets.

Risk (in finance)

The degree of uncertainty associated with the return on one asset relative to alternative assets.

Liquidity

The ease and speed with which an asset can be turned into cash relative to alternative assets.

Bond Demand and Interest Rates

At lower bond prices (higher interest rates), the quantity demanded of bonds is higher, illustrating an inverse relationship.

Bond Supply and Interest Rates

At lower bond prices (higher interest rates), the quantity supplied of bonds is lower, illustrating a positive relationship.

Market Equilibrium

Occurs when the amount people are willing to buy equals the amount they are willing to sell at a given price.

Wealth and Bond Demand

In an expansion with growing wealth, the demand curve for bonds shifts to the right.

Expected Interest Rates and Bond Demand

Higher expected interest rates in the future lower the expected return for long-term bonds, shifting the demand curve to the left.

Expected Inflation and Bond Demand

An increase in the expected rate of inflation lowers the expected return for bonds, causing the demand curve to shift to the left.

Risk and Bond Demand

An increase in the riskiness of bonds causes the demand curve to shift to the left.

Liquidity and Bond Demand

Increased liquidity of bonds results in the demand curve shifting right.

Expected Profitability of Investment Opportunities and Bond Supply

In an expansion, the supply curve shifts to the right.

Expected Inflation and Bond Supply

An increase in expected inflation shifts the supply curve for bonds to the right.

Government Budget Deficits and Bond Supply

Increased budget deficits shift the supply curve to the right.

Liquidity Preference Framework

Keynesian model that determines the equilibrium interest rate in terms of the supply of and demand for money.

Demand for Money in Liquidity Preference Framework

As the interest rate increases, the opportunity cost of holding money increases, and the relative expected return of money decreases, therefore the quantity demanded of money decreases.

Income Effect (Money Demand)

A higher level of income causes the demand for money at each interest rate to increase, and the demand curve shifts to the right.

Price-Level Effect (Money Demand)

A rise in the price level causes the demand for money at each interest rate to increase, and the demand curve shifts to the right.

Shifts in the Supply of Money

An increase in the money supply engineered by the Federal Reserve will shift the supply curve for money to the right.

Liquidity Effect

An increase in the money supply will lower interest rates.

Income Effect (Money Supply)

Increasing the money supply is an expansionary influence on the economy, which causes interest rates to rise.

Price-Level Effect (Money Supply)

Predicts that an increase in the money supply leads to a rise in interest rates in response to the rise in the price level.

Expected-Inflation Effect (Money Supply)

Shows an increase in interest rates because an increase in the money supply may lead people to expect a higher price level in the future.