Financial Markets and the Economy

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• Financial Markets and the Economy
• Read Chapter 10 pages 204 220
• I The Bond and Foreign Exchange Markets.
• A financial market is a market where funds
  accumulated by one group are made available to
  another group.
• B) The Bond Market
• 1) Bond prices and interest rates
• a) The maturity date of a bond is the date
  when the loan matures or comes due.

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• b) The face value of a bond is the amount the
  issuer will have to pay on the maturity date of
  the bond.
• c) An interest rate is the payment made for
  the use of money expressed as a percentage of the
  amount borrowed.
• d) Interest rate
• ((Face value-bond price)/bond price) x 100
• e) Example
• ((1,000-950)/950) x 100 5.3

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• f) Note that a higher price corresponds to a
  higher lower interest rate and a lower price
  corresponds to higher interest rates.

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• 2) The Bond Market and Macroeconomic Performance.
• a) When bond prices go up, real GDP and the
  price level rise.
• b) When bond prices go down, real GDP and the
  price level may fall.

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• C) Foreign Exchange Markets
• The foreign exchange market is a market in which
  currencies of different countries are traded with
  one another.
• 2) An exchange rate is the price of its currency
  in terms of another currency.
• Example 121 Yen/ is the price of a in
  terms of yen.
• 3) A trade-weighted exchange rate is an index of
  exchange rates.

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• 4) Determining Exchange rates.
• a) Demand curves relates the number of dollars
  buyers want to buy in any period of exchange.
• b) Supply curve relates the number of dollars
  sellers want to sell in any period of exchange.
• c) Higher exchange means U.S. products are more
  expensive and reduces the demand for them. Lower
  exchange is the opposite.

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• 5) Exchange Rates and Macroeconomic Performance.
• a) Demand for currency comes from both a
  demand for domestic products and a demand for
  domestic assets.
• b) If bond supply increases, then prices of
  bonds will fall, interest rates will rise, and
  there demand for currency from foreigners will
  rise pushing up the exchange rate and reducing
  aggregate demand for goods.

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• II Demand and Supply and Equilibrium in the Money
  Market.
• The demand for money.
• 1) The demand for money is the relationship
  between the quantity of money people want to hold
  and the factors that determine that quantity.
• 2) Motives for holding money.
• a) The transactions demand for money is money
  people hold to pay for goods and services they
  anticipate buying.

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• b) The precautionary demand for money is money
  people hold for contingencies.
• c) The speculative demand for money is the
  money held in response to concern that bond
  prices and the prices of other financial assets
  might change.
• B) Interest rates and the demand for money.
• Holding money represents an opportunity cost
  in the form of foregone interest income.

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• C) The Demand curve for money shows the quantity
  of money demanded at each interest rate, all
  other things unchanged.
• 1) It slopes downward.
• 2) It shifts due to
• a) Real GDP
• b) The price level
• c) Expectations
• d) Transfer Costs
• e) Preferences

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• D) The Supply of Money
• 1) The supply curve of money shows the
  relationship between the quantity of money
  supplied and the market interest rate, all other
  determinants of supply unchanged.
• 2) Typically we assume the central bank has
  complete control over the money supply and thus
  the money supply curve is vertical

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• E) Equilibrium in the Market for Money.
• 1) The money market is the interactions among
  institutions through which money is supplied to
  individuals, firms and other institutions that
  demand money.
• 2) Money Market equilibrium occurs at the
  interest rate at which the quantity of money
  demanded is equal to the quantity of money
  supplied.

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• F) Effects of changes in the Money Market.
• Illustration of an expansionary monetary policy.
• Fed expands the money supply by buying bonds
  (I.e. handing out money), this increases the
  demand for bonds, driving up their price,
  reducing interest rates and stimulating
  investment and thus aggregate demand.

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