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Money and Banking ch5

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26 views12 pages

Money and Banking ch5

Uploaded by

Youstina Magdy
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PPTX, PDF, TXT or read online on Scribd
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The Economics of Money, Banking, and

Financial Markets
Twelfth Edition, Global Edition

Chapter 5
The Behavior of Interest Rates

Copyright © 2019 Pearson Education, Ltd.


Preview
• In this chapter, we examine how the overall level of nominal
interest rates is determined and which factors influence their
behavior.

Copyright © 2019 Pearson Education, Ltd.


Chapter Outline

1. Identify the factors that affect the demand for assets (portfolio
theory).
2. Draw the demand and supply curves for the bond market and
identify the equilibrium interest rate.

Copyright © 2019 Pearson Education, Ltd.


Determinants of Asset Demand (1 of 2)
• An asset is anything that can be owned and has value.(including
money, bonds, stocks, cars , houses and land)
• Whether to buy one asset rather than another an individual must
consider the following factors:
– Wealth: the total resources owned by the individual, including all
assets (An increase in wealth raises the quantity demanded of an
asset). (+ ve)
– Expected Return: the return expected over the next period on one
asset relative to alternative assets. (an increase in an asset’s
expected return relative to that of an alternative asset, raises the
quantity demanded of the asset). (+ ve)

Copyright © 2019 Pearson Education, Ltd.


Determinants of Asset Demand (2 of 2)

– Risk: the degree of uncertainty associated with the return on one asset
relative to alternative assets. (if an asset’s risk rises relative to that of
alternative assets, its quantity demanded will fall) (- ve)
– Liquidity: the ease and speed with which an asset can be turned into
cash relative to alternative assets. (The more liquid an asset is relative to
alternative assets, the more desirable it is and the greater the quantity
demanded will be ). (+ ve)

Copyright © 2019 Pearson Education, Ltd.


Theory of Portfolio Choice (1 of 2)
Holding all other factors constant:
1. The quantity demanded of an asset is positively related to
wealth
2. The quantity demanded of an asset is positively related to
its expected return relative to alternative assets
3. The quantity demanded of an asset is negatively related to
the risk of its returns relative to alternative assets
4. The quantity demanded of an asset is positively related to
its liquidity relative to alternative assets

Copyright © 2019 Pearson Education, Ltd.


Theory of Portfolio Choice (2 of 2)

Summary Table 1
Response of the Quantity of an Asset Demanded to Changes in Wealth,
Expected Returns, Risk, and Liquidity

Variable Change in Variable Change in Quantity


Demanded
Wealth ↑ ↑
Expected return relative to other assets ↑ ↑
Risk relative to other assets ↑ ↓
Liquidity relative to other assets ↑ ↑

Copyright © 2019 Pearson Education, Ltd.


Supply and Demand in the Bond Market
As we know there is a negative relationship between bond prices and
interest rates means that when a bond’s price rises, its interest rate falls

Copyright © 2019 Pearson Education, Ltd.


Supply and Demand in the Bond Market

• At lower prices900 (higher interest rates %11.1), ceteris paribus,


the quantity demanded of bonds is higher: an inverse
relationship

• At lower prices (higher interest rates), ceteris paribus, the


quantity supplied of bonds is lower: a positive relationship (cost
of issue bond increase at higher interest rate)

Copyright © 2019 Pearson Education, Ltd.


Figure )1( Supply and Demand for Bonds

Copyright © 2019 Pearson Education, Ltd.


Market Equilibrium
• Occurs when the amount that people are willing to buy (demand)
equals the amount that people are willing to sell (supply) at a
given price.
• At point C the equilibrium is determined when : Bd = Bs at a
bond price of $850 (interest rate of 17.6%) and a quantity of
bonds of $300 billion.
• When Bd > Bs , there is excess demand, price will rise and
interest rate will fall.
• When Bd < Bs , there is excess supply, price will fall and interest
rate will rise.

Copyright © 2019 Pearson Education, Ltd.


Changes in Equilibrium Interest Rates

• It is important to make the distinction between movements along a


demand (or supply) curve and shifts in a demand (or supply) curve
– When quantity demanded (or supplied) changes as a result of a
change in the price of the bond (or, equivalently, a change in the
interest rate), we have a movement along the demand (or supply)
curve.
– A shift in the demand (or supply) curve, of the bond in response to
a change in some other factor besides the bond’s price or interest
rate. When one of these factors changes, causing a shift in the
demand or supply curve.

Copyright © 2019 Pearson Education, Ltd.

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