MacroEconomic - Unit 4

Financial Assets

• Money is anything that can be used to purchase goods and services.

• Wealth is an accumulation of savings through the purchase of assets (with money) that occurs over time.

Financial Assets

Written claims where buyers have the right to future income from sellers.

Ex: Cash, demand deposits (checking accounts), loans, stocks, and bonds.

Can be physical assets, like land, homes, or cars

• An asset is anything that holds value, that the owner has a written claim to future income from the seller

Liquidity

How easily the asset can be turned into cash

• Cash is the most liquid financial asset (Checking accounts, demand deposits are also liquid)

How easily can each of these items be converted into cash depends on time and energy

• Some harder assets to turn into cash are bonds and saving accounts

How do assets old value

Assets allow the holder to accumulate wealth over time (storing money in assets allows for the asset to grow due to interest over time in the growth of the aggregate economy) and they are both an asset and a liability

Loans

Borrowing money

Loans are critical in the growth of the aggregate economy (Both an asset and a liability)

Bonds

A bond has a term - the number of years the holder can earn interest. After a bond comes to maturity (Date you must pay the amount back) the bond holder gets the face value of the bond plus the interest it earned over its term.

• Bonds are most commonly issued by governments in order to take money for government projects and pay the loan back with interest

• Investors are attracted to financial assets that have higher rates of return than other assets

• Bonds are key to understanding the role of financial institution in creating and regulating our money supply

• The price of previously issued bonds and interest rates have an inverse relationship (Current interest rate on bonds falls, previously issued bonds increase, vice versa)

The interest rate of previously issued bonds is much more attractive now, driving demand for those bonds up (When the demand for previously issued bonds rises, the price rises, vice versa)

(Rate of return = Real interest rate)

Opportunity Cost of Holding Money

When individuals hold money, there is an opportunity cost to the decision.

The cost is the interest the money could be earning in an interest-bearing asset (Includes bonds)

If consumers hold money rather than bonds because they expect the interest rate to increase in the future this is a speculation

Nominal Vs. Real Interest Rates

Nominal Interest Rates

Nominal interest rates are rates that you see when doing business with a financial institution.

These are rates that are paid on a loan, and it is not adjusted for inflation

Real Interest rates

Real interest rates are the real rate of return earned on financial assets or paid back on loans

These are rates that are adjusted for inflation

The Fisher Effect

An equation that helps us calculate the real rate of return on investments, financial assets, and loans (Impact of inflation on nominal and real interest rates)

Nominal Interest rate = Real interest rate + inflation

Inflation = Nominal interest rate - Real interest rate

Real interest rate = Nominal - inflation

• (mostly algebra)

* When people choose to purchase financial assets, they take into account their expected Real rate of return, which is based on expected / anticipated inflation

Expected vs. Unexpected Inflation

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