Financial Flows and Money Markets Economics 71a Spring 2007 Mayo, chapter 1 Lecture notes 2.1
Financial Flows and Money Markets Economics 71a Spring 2007 Mayo, chapter 1 Lecture notes 2.1.
Dec 20, 2015
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Financial Flows and Money Markets
Economics 71a
Spring 2007
Mayo, chapter 1
Lecture notes 2.1
Outline
Finance fundamentals Investment characteristics
Term Liquidity Return Risk States of nature
Money connections Interest rates
Finance Fundamentals and Functions
Firms
Consumers
Savings
Invest Payout
Return
Time
Finance Fundamentals and Functions
Firms
Consumers
Savings
Invest Payout
Return
Time
Intermediaries/Financial Service Firms
Finance Fundamentals and Functions
Consumers
Consumers
Savings
Borrow Repay loans
Return
Time
Intermediaries/Financial Service Firms
Investment Characteristics
Term Length of time
Liquidity Ease of buying and selling
Return Risk States of nature
Money Connections
Money Store of value Transaction medium Unit of account
Monetary Instruments(High to Low Liquidity)
Cash Debit cards Checking accounts Money market accounts Government bonds Much less liquid (Are these money?)
U.S. Stocks Corporate bonds Gold
Credit Cards
What are they? Not a store of value Not an investment
Roles Transactions Borrowing
Interest Rates
Key price for many financial instruments
Interest Rate Units
Usually in percentage termsExample
Annual interest rate = 8% Time period here = 1 year Lenders lending $100 get $108 in 1 year Borrowers getting $100 loan, pay back
$108 in 1 year
Real Interest Rates
Nominal rate of interest Rate before inflation adjustment
Real rate of interest Rate after adjusting for inflation
More later
Interest Rate Determination
D = demand for loans
InterestRate
Quantity of loans
S = lender supply
What happens when the economy “heats up”
D = demand for loans
InterestRate
Quantity of loans
S = lender supply
Shifts in Demand and Supply for Loans and Savings
During good times Firms increase demand for loans People probably increase demands for
loans Interest rate rises
What about personal savings? Less clear
Shifts in Demand and Supply for Loans and Savings
Government Borrowing The government is a major player too If it increases or decreases its borrowing
the demand for loans will change
Different Interest Rates
Rates vary over Time (maturities) Risk
Probability of default
Time: The Term Structure
Different rates for different horizons 6 month 1 year 2 years 5 years 10 years 30 years
Yield Curve
1 2 5 10 20
Years into futureTime of maturity
Interest RateAnnual %
5%
The Yield Curve
The yield curve changes over timeSee “The living yield curve” Inverted yield curvesThe yield curve and GDP
Risk/Return Tradeoff
Return
Risk
U.S. Stocks
U.S. Corporate Bonds
U.S.Government Bonds
EmergingMarketStocks
Outline
Finance fundamentals Investment characteristics
Term Liquidity Return Risk States of nature
Money connections Interest rates
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