Money and Banking Midterm No. 1

Financial Markets

Act as intermediates to bring savors together with borrowers

Primary Markets

Savors and borrowers initially meet in the primary market, where financial instruments or assets are initially sold

Secondary Market

Re-selliing and buying takes place in the secondary market

Market for Risk

This is the insurance market

Money

Anything that is generally accepted in exchange for a good or service

3 functions of money

Medium of exchange, Unit of account, store of value

Monetary aggregates: M1 & M2

M1: Currency + Checkable deposits + Travelers check

M2: M1 + Saving deposits + including money market deposit accounts + small denominated time deposits + money market mutual funds

Time Value of money

Money received today has more value than money received in the future

Futute Value

The nominal value of an asset, such as money, at some point in time in the future

How to find future value

PV(1+i)^n=FV

Financial Markets

Where savers and borrowers come together. Bond market is an important part of the financial market.

Bond

A written legal contract that is a promise to repay with interest; that is issued by a corporation, government, or government agency

Coupon rate

that stated rate of interest that will be paid to the holder of the bond

Face value

The original amount of money borrowed by the bond issuer, also known as bond principal

Market price of a bond

present value of cash flow the bond owner can expect to receive over the life of the bond

Par

Market price of the bond equals its face value

Discount

when market price of a bond is lower than its face value

Premium

When the market price of a bond is above its face value

Supply curve

Direct relationship between price and quantity supplied

What causes shifts in the supply curve

Business expectation, expected inflation, government deficits, investment tax credit

Demand curve

Inverse relationship between price and quantity demanded. When bonds increase interest rates decrease, therefore quantity of bonds demanded increase

What causes shift on the demand curve

Wealth, Expected relative returns to bonds, Liquidity of bonds, information cost, riskiness of bond (default risk)

Which way does the supply curve of loanable funds go?

Upwards

Which way does the demand for loanable funds go

downward

How does business confidence effect the economy

As business confidence increases, borrowing and spending rises leading to economic expansion. Increase in borrowing lead to higher market interest rates

Default risk

The borrower will not pay interest or principal, or both

Default risk premium (DRP)

The difference between yields in assets with different level of default risk

Flight to quality

Movement of financial assets from one financial instrument with high DRP to one with lower DRP

Default risk premium spread

The difference in yields between assets with different levels of default risk

Fisher equation

Nominal or market IR= Real IR + Rate of inflation

Equation for finding Ex post real interest

Ex post real IR = Nominal interest - actual inflation rate

Equation for finding Ex ante real interest

Ex ante real interest = nominal interest - expected inflation rate

Before and after tax return

Investors and savers are interested in the after tax rate of return

After tax return formula

iat= ibt(1-z)

Muni Bonds

bonds or debt issued by state gov, local gov, and or local municipalities. Interest paid on muni bonds are currently not subjected to federal income tax

What does an upward yield curve indicate

the market expects short-term rates to be higher in the future than they currently are

what does a downward yield curve mean

suggest that short term interest rates will be lower in the future than they are today

what does a flat yield curve mean

that the market expects interest rates in the future to remain the same as they currently are

Pure expectations theory

a frame work where long term interest rates are based on the expectations of what short-term interest rates will be in the future

Term premium theory

A frame work where long term bonds have higher yields than shorter term bonds as a way of creating incentive for bond buyers to purchase the less desirable longer-term bonds

Segmented market theory a framework

a framework where the short-term, medium-term, and long-term bond markets are all different or segmented markets. The long-term savers have different objectives and goals than those savers interested in buying short-term bonds

Panic of 1907

Financial crisis triggered by wild speculation in the stock market and loose lending practices by banks

Federal reserve act of 1913

established a quasi-governmental agency, an entity created by the federal gov but not fully apart of it. Commercial banks were required to purchases shares in order to raise capital and begin operations

Which policy did the Fed reserve follow that worsened the Great Depression

Burgess-Riefler doctrine

What historic even helped us climb out of depression

WWII

Stagflation

A time when the economy suffers from high rates of inflation and economic stagnation, often a high and/or increasing unemployment rate.

Which Fed Reserve chairman worsened US inflation

Paul Volcker

What was the goal of Regan Administration policy (DIDMCA)

to reduce the amt of regulation in financial market

Garn–St. Germain Act

An act designed to reduce the amount of regulation over the Savings & Loan industry