Econ 29 Notes Financial markets: markets in which funds are transferred from people who have an excess of available

funds to people who have a shortage Such as bond and stock markets crucial to promoting greater economic efficiency by channeling funds from people who do not have a productive use for them to people who do

Security: is a claim on the issuers future income or assets Asset: any financial claim or piece of property that is subject to ownership Bond: a debt security that promises to make payments periodically for a specified period of time Enables corporations and governments to borrow to finance their activities and because it is where interest rates are determined

Interest rate: cost of borrowing or the price paid for the rental of funds High interest rates could deter you from buying a house or a car cause the cost of financing it would be high High interest rates encourage you to save because you can earn more interest income by putting aside some of your earnings or savings Interest rates impact health of economy because they effect business investment decisions high interest rates postpone building that would provide more jobs The interest rate on a three-month treasury bill fluctuates more than other interest rates and is lower

Common stock: share of ownership in corporation Security that is a claim on the earnings and assets of the corporation Issuing stock and selling it to public is a way for corporations to raise funds to finance their activities Effects business investment decisions because price of shares affects the amount of funds that can be raised by selling newly issued stock to finance investment spending a higher price for a firms shares means that it can raise a larger amount of funds, which it can use to buy production facilities and equipment

Financial intermediaries: institutions that borrow funds from people who have saved and in turn make loans to others Financial system seized up and produces

Financial crises: major disruptions in financial markets that are characterized by sharp declines in asset prices and the failures of many financial and nonfinancial firms

Banks: financial institutions that accept deposits and make loans Commercial banks, savings and loan associations, mutual savings banks, and credit unions Most people keep wealth in banks in form of checking accounts, savings accounts, or other types of bank deposits

e-finance: new means of delivering financial services electronically How creative thinking can lead to higher profits

Money: anything that is generally accepted in payment for goods or services in the repayment of debts Money generates Business cycles: upward and downward movement of aggregate output produced in the economy Recession: periods of declining aggregate output Aggregate price level: average price of goods and services in an economy Inflation: continual increase in price level, affects individuals, businesses, and govt. Continuing increase in money supply might be an important factor in causing the continuing increase in price level (inflation) Money plays important role in interest-rate fluctuations

Monetary policy: management of money and interest rates Central bank: responsible for the conduct of a nations monetary policy Federal Reserve System: U. S central bank Fiscal policy: decisions about government spending and taxation Budget deficit: excess of government expenditures over tax revenues for a particular time period, typically a year Budget surplus: tax revenues exceed government expenditures Government must finance any deficit by borrowing while a budget surplus leads to a lower government debt burden

Foreign Exchange Market: where conversion of currency takes place, moves funds between countries also where foreign exchange rate (price of one countrys currency in terms of another) is determined Change in exchange rate has a direct effect on American consumers because it affects the cost of imports When the value of a dollar drops, Americans decrease their purchases of foreign goods and increase their consumption of domestic goods

Strong dollar benefited American consumers by making foreign goods cheaper but hut American businesses and eliminated jobs by cutting both domestic and foreign sales of their products Decline in value of dollar made foreign goods more expensive, but made American businesses more competitive Increase in capital flows among countries heightens the international financial systems impact on domestic economies

Gross Domestic product: market value of all final goods and services produced in a country during the course of a year Doesnt include items purchased in the past and the purchases of stocks and bonds also intermediate goods

Aggregate income: total income of factors of production from producing goods and services in the economy during the course of a year, is best thought of as being equal to aggregate output Income payments are equal for final goods and services because payments for final goods and services must eventually flow back to owners of factors of production as income

Nominal GDP: when total value of final goods and services using current prices is calculated, resulting GDP Real GDP: GDP measured in terms of fixed prices Real variables measure quantities of goods and services and do not change because prices have changed, but only if actual quantities change

GDP deflator: nominal GDP/real GDP PCE deflator: nominal personal consumption expenditures/ real PCE Consumer price index: measured by pricing a basket of goods and services bought by a typical urban household These aggregate price level indicators can be used to convert or deflate a nominal magnitude into a real magnitude by the price index

Growth rate: percentage change in a variable Inflation rate: growth rate of the aggregate price level Direct finance: borrowers borrow funds directly from lenders in financial markets by selling them securities Important because people who save are frequently not the same people who have profitable investment opportunities available to them, the entrepreneurs

Financial markets critical for producing capital, which contributes to higher production and efficiency for the overall economy Allow consumers to time their purchases better

Liabilities: IOUs or debts, securities for the individuals that sell them Issue a debt instrument: such as a bond or mortgage, which is a contractual agreement by the borrower to pay the holder of the instrument fixed dollar amounts at regular intervals until a specified date, when a final payment is made Maturity: number of years until that instruments expiration date Short-term debt instrument: maturity is less that a year Long-term debt instrument: ten years or longer Issuing equities: claims to share in the net income and the assets of business Dividends: Equities often make these periodic tables to their holders and are considered long-term securities because they have no maturity date Disadvantage of owning corporations equities rather than its debt is that an equity holder is a residual claimant corporation must pay all its debt holders before it pays its equity holders Advantage of holding equities is that equity holders benefit directly from any increases in the corporations profitability or asset value because equities confer ownership rights on equity holders Debt holders do not share in this benefit, because their dollar payments are fixed

Primary market: financial market in which new issues of a security, such as bond or stock, are sold to initial buyers by the corporation or government agency borrowing the funds Secondary market: financial market in which securities that have been previously issued can be resold (NASDAQ and NYSE, futures markets, foreign exchange markets, and options markets) When person buys a security in secondary market, person who has sold the security receives money in exchange for the security, but the corporation that issued the security acquires no new funds A corporation only requires new funds when its securities are first sold in primary market Secondary markets make it easier and quicker to sell these financial instruments to raise chase make financial instruments more liquid More liquidity makes them more desirable and easier for the issuing firm to sell in primary market

Investors who buy securities in primary market will pay issuing corporation no more than the price they think the secondary market will set for this security Higher the securities price in the secondary market, the higher the price that the issuing firm will receive for a new security in the primary market, hence greater the amount of financial capital it can raise Conditions in secondary market are therefore the most relevant to corporations issuing securities Can be organized in two ways:

Exchanges: buyers and sellers of securities meet in one central location to conduct trades Over the counter market: dealers at different locations who have an inventory of securities stand ready to buy and sell securities over the counter to anyone who comes to them and is willing to accept their prices Brokers: agents and investors who match buyers and sellers of securities Dealers: link buyers and sellers by buying and selling securities at stated prices Investment bank: important financial institution that assists in the initial sale of securities in the primary market Does this by underwriting securities guarantees a price for the corporations securities and then sells them to the public

Money market: financial market in which only short-term debt instruments are traded Because of their short-term maturity the debt instruments traded in the money market undergo the lest price fluctuations and so are the least risky investments

United States Treasury Bills: Most liquid of all money market instruments because there is almost no possibility of default (situation which party issuing the debt instrument is unable to make interest payments or pay off the amount owed when the instrument matures) Issue in one, three, and six month maturities to finance federal government They pay a set amount at maturity and have no interest payments, but they have effectively pay interest by initially selling at a discount, at a price lower than the set amount paid at maturity Fed govt. always meets its debt obligations because it can raise taxes or issue currency to pay off debts Bills held mainly by banks, although small amounts are held by households, corporations, and other financial intermediaries

Negotiable Bank Certificates of Deposit: Debt instrument sold by a bank to depositors that pays annual interest of a given amount and at maturity pays back the original purchase price

Negotiable CDs sold in secondary markets and an extremely important source of funds for commercial banks

Commercial Paper: short -term debt instrument issued by large banks and well-known corporations Repurchase Agreements: short-term loans (maturity of less than two weeks) for which Treasury bills serve as collateral Most important lenders in market are large corporations

Federal Funds: overnight loans between banks of their deposits at the Federal Reserve Loans not made by federal government or by federal reserve, but by banks to other banks Bank might borrow from other bank because it does not have enough deposits at the Fed to meet the amount required by regulators Market is sensitive to credit needs of banks, so interest rate on these loans is called the deferral funds rate which is a closely watched barometer of the tightness of credit market conditions in the banking system and the stance of monetary policy When it is high it indicates banks are strapped for funds, when it is low, banks credit needs are low

Capital market: market in which longer-term debt and equity instruments are traded Money market securities are usually more widely traded than longer-term securities and tend to be more liquid Short term securities have smaller fluctuations in prices than long-term securities, making them safer investments Corporations and banks actively use the money market to earn interest on surplus funds that they expect to have only temporarily Capital market securities, such as stocks and long-term bonds, are often held by financial intermediaries such as insurance companies and pension funds, which have little uncertainty about the amount of funds they will have available in the future

Stocks: equity claims on net income and assets of a corporation Amount of new tock in a year is small Individuals hold around half of the value of stocks, rest are half by pension funds, mutual funds, and insurance companies

Mortgages: loans to households or firms to purchase housing, land, or other real structures, where the structure or land itself serves as collateral for the loans Mortgage market is the largest debt market Savings, loan associations, and commercial banks are primary lenders in residential mortgage market

Majority of commercial and farm mortgages are made by commercial banks and life insurance companies Federal government plays an active role in mortgage market via three agencies: federal national mortgage association, government national mortgage association, federal home loan mortgage corporation that provide funds to mortgage market by selling bonds and using the proceeds to buy mortgages

Corporate bonds: long-term bonds issued by corporations with very strong credit ratings Typical corporate bond sends the holder an interest payment twice a year and pays off the face value when the bond matures Convertible bonds have additional feature of allowing holder to convert them into a specified number of shares of stock at any time up to the maturity date Because the amount of corporate bonds is small they are not very liquid Volume of new corporate bonds is greater than new stocks Thus the behavior of the corporate bond market is more important to a firms financing decisions that the stock market Principal buyer of corporate bonds are life insurance companies, pension funds and households

U.S government securities: long-term debt instruments issue by U.S treasury to finance deficits of federal government Most liquid security traded in capital market Held by Federal Reserve, banks, and households

U.S government agency securities: long-term bonds issued by various government agencies to finance such items as mortgages, farm loans, or power equipment Guaranteed by federal govt. Function like U.S government bonds and are held by similar parties

State and local government bonds: also called municipal bonds, are long-term debt instruments issued by state and local governments to finance expenditures on schools, roads, and other large programs Interest payments are exempt from federal income tax and generally from state taxes in the issuing state Commercial banks with high income tax rate are biggest buyers of these securities

Consumer and Bank commercial loans: made by banks to consumers and businesses, but in consumer loans also made by finance companies Foreign bonds: instruments in the international bond market Sold in foreign countries and are denominated in U.S dollars, it is classified as a foreign bond

Eurobond: bond denominated in a currency other than that of the country in which it is sold Eurocurrencies: foreign currencies deposited in banks outside the home country Eurodollars: U.S dollars deposited in foreign banks outside the U.S or in foreign branches of U.S banks Because they earn interest they are similar to short-term Eurobonds Now an important source of funds for American banks Bond denominated in Euros is called a Eurobond only if it is sold outside the countries that have adopted the euro

World Stock markets: Increased interest in foreign stocks has prompted the development in the U.S of mutual funds that specialize in trading in foreign stock markets Foreigners are not only providing funds to corporations in the U.S, but are also helping finance the federal government Leading the way to more integrated world economy in which flows of goods and technology between countries are more commonplace

Financial intermediation: indirect finance using financial intermediaries is the primary route for moving funds from lenders to borrowers Transaction costs: time and money spent in carrying out financial transactions Economies of scale: reduction in transaction costs per dollar of transactions as the size of transactions increase (what intermediaries do) Liquidity services: services that make it easier for customers to conduct transactions (because of low transaction costs) In addition, depositors can earn interest on checking and savings accounts and yet still convert them into goods and services whenever necessary

Risk: uncertainty about the returns investors will earn on assets (investors reduce risk by low transaction costs) Risk sharing: they create and sell assets with risk characteristics that people are comfortable with and the intermediaries then use the funds they acquire by selling these assets to purchase other assets that may have far more risk Low transaction costs allow financial intermediaries to share risk at low cost, enabling them to earn a profit on the spread between the returns they earn on risky assets and the payments they make on the assets they have sold

Asset transformation: risky assets are turned into safer assets for investors

Diversification: entails investing in a collection of assets whose returns do not always move together, with the result that overall risk is lower than for individual assets Low transaction costs allow financial intermediaries to do this by pooling a collection of assets into a new asset and then selling to individuals

Asymmetric information: one party does not know enough about the other party to make accurate decisions Adverse selection: problem created by asymmetric information before the transaction occurs Occurs when potential borrowers who are most likely to produce an undesirable outcome are the ones who most actively seek out a loan and are thus more likely to be selected Because adverse selection makes it more likely that loans might be made to bad credit risks, lenders may decide not to make any loans even though there are good credit risks in the marketplace

Moral hazard: problem created by asymmetric information after the transaction occurs It is the risk that the borrower might engage in activities that are undesirable from the lenders point of view, because they make it less likely that the loan will be paid back Lowers probability that the loan will be repaid, lenders may decide that they would rather not make a loan

Depository Institutions: financial intermediaries that accept deposits from individuals and institutions and make loans They are involved in the creation of deposits Include commercial banks and thrift institutions

Thrift institutions: savings and loan associations, mutual savings banks, and credit unions Commercial banks: raise funds primarily by issuing checkable deposits Use these funds to make commercial, consumer, and mortgage loans to buy U.S government securities and municipal bonds

Savings and loan associations and mutual savings banks: obtain funds primarily through savings deposits and time and checkable deposits In past mostly made mortgage loans for residential housing Over time restrictions loosened so that the distinction between these depository institutions and commercial banks has blurred More alike and more competitive

Credit Unions: very small cooperative lending institutions organized around a particular group: union members, employees of a particular firm, and so forth Acquire funds from deposits called shares and primarily make consumer loans

Contractual savings institutions: financial intermediaries that acquire funds at periodic intervals on a contractual basis Because they can predict with reasonable accuracy how much they will have to pay out in benefits in the coming years, they do not have to worry as much as depository institutions about losing funds quickly As a result the liquidity of assets is not as important a consideration for them as it is for depository institutions, and they tend to invest their funds primarily in long-term securities such as corporate bonds, stocks and mortgages

Life insurance companies: insure people against financial hazards following death and sell annuities Acquire funds from premiums and people pay to keep their policies in force and use them mainly to by corporate bonds and mortgages Purchase stocks, but are restricted in the amount that they can hold

Fire and Casualty insurance: insure their policyholders against loss from theft, fire, and accidents Like half insurance companies, receiving funds through premiums for their policies, but they have a greater possibility of loss of funds if major disasters occur Use funds to buy more liquid assets than life insurance companies do hold municipal and corporate bonds and stocks

Pension funds and government retirement funds: provide retirement income in the form of annuities to employees who are covered by a pension plan Funds acquired by contributions from employees, who either have a contribution automatically deducted from their paychecks or contribute voluntarily Been actively encouraged by federal government both through legislation pension plans and through tax incentives to encourage contributions

Investment intermediaries Finance companies: sell commercial paper and issue stocks and bonds; lend funds to consumers who make purchases of large assets Mutual funds: acquire funds by selling shares to many individuals and use the proceeds to purchase diversified portfolios of stocks and bonds Allow shareholders to pool their resources so that they can take advantage of lower transaction costs when buying large blocks of stocks or bonds

Allow shareholders to hold more diversified portfolios than the otherwise would Shareholders can sell shares at any time, but the value of these shares will be determined by the value of the mutual funds holdings of securities They fluctuate greatly, value of mutual fund shares will too; therefore investments in mutual funds can be risky

Money market mutual funds: characteristics of a mutual fund, but also function some extent as a depository institution because they offer deposit-type accounts Sell shares to acquire funds that are then used to buy money market instruments that are both safe and very liquid Interest paid out to shareholders Shareholders can write checks against the value of their shareholdings Function like checking account deposits that pay interest

Investment banks: helps corporation issue securities Advises corporation on which type of securities to issue; then it helps underwrite the securities by purchasing them from the corporation at a predetermined price and reselling them in the market Also act as dealmakers and earn enormous fees by helping corporations acquire other companies through mergers

Regulation of Financial System: Increase information available to investors and ensure the soundness of the financial system Financial panic: asymmetric information can lead to widespread collapse of financial intermediaries Government has implemented regulations

Restrictions on entry: tight regulations governing who is allowed to set up financial intermediaries must obtain a charter from the state or federal government Disclosure: stringent reporting requirements bookkeeping, inspections, and information available to public Restrictions on assets and activities: restrict financial intermediary from engaging in certain risky activities and restrict it from holding certain risky assets Deposit insurance: the government can insure peoples deposits so that they do not suffer great financial loss if the financial intermediary that holds these deposits should fail Federal deposit insurance corporation Limits on competition: competition amongst financial intermediaries often promotes failure will harm the public and often oppose the opening of new locations Restrictions on interest rates: competition that has also been inhibited b regulations that impose restrictions on interest rates that can be paid on deposits

Money: anything that is generally accepted in payment for goods or services in the repayment of debts - Is a stock: it is a certain amount at a given point in time Currency: dollar bills and coins fit definition of money Wealth: the total collection of pieces of property that serve to store value Income: flow of earnings per unit of time Medium of Exchange: money used to pay for goods and services Using money as a medium of exchange promotes economic efficiency by minimizing the time spent in exchanging goods and services In barter economy transaction costs are high because people have to satisfy double coincidence of wants find someone who has a good or service they want and who also wants the good or service they have Money must be easily standardized, widely accepted, and divisible, easy to carry, and deteriorate quickly

Unit of account: used to measure value in the economy Measure value of goods and services in terms of money Reduces transaction costs by reducing number of prices that need to be considered

Store of value: repository of purchasing power over time Used to save purchasing power from the time income is received until the time it is spent Assets have advantages over money as a store of value: often pay the owner a higher interest rate than money, experience price appreciation, and deliver services such as providing a roof over ones head Store of value depends on price level

Liquidity: relative easy and speed with which an asset can be converted into a medium of exchange Because money is most liquid asset, people are willing to hold if even if it is not the most attractive store value

Hyperinflation: inflation rate exceeds 50% per month Payments system: method of conducting transactions in the economy Commodity money: money made up of precious metals or another valuable commodity Problem was that is was very heavy and hard to transport

Fiat money: paper currency decreed by governments as legal tender but not convertible unto coins or precious metal, but it can be accepted as a medium of exchange only if there is some trust in the authorities who issue it and if printing has reached a sufficiently advanced stage that counterfeiting is extremely difficult Problem is that paper currency and coins are easily stolen and can be expensive to transport in large amounts because of their bulk

Checks: instruction from you to your bank to transfer money from your account to someone elses account when she deposits the check Allow transactions to take place without the need to carry around large amounts of currency With checks, payments that cancel each other can be settled by cancelling the checks and no currency need to be moved Checks reduce the transportation costs associated with the payments system and improves economic efficiency Can be written for any amount up to the balance in the account, making transactions for large amounts much easier Checks lost from theft is greatly reduced, and because they provide convenient receipts for purchases Problem: takes time to get checks from one place to another and it takes a long time for the check to be deposited and available All paper shuffling required to process checks is costly

Electronic payment: Paying bills electronically E-Money: money that exists only in electronic form (debit card, stored value card) E-cash: money used on Internet to purchase goods or services Monetary aggregates: measure of money M1: includes most liquid assets: currency, checking account deposits, and travelers checks Currency component includes money in coins not in banks Travelers checks not issued by banks Demand deposits that do not pay interest and not issued by banks Other checkable deposits held by households

M2: M1 plus assets that are not as liquid: assets that have checking writing features and other assets that can be turned into cash quickly at very little cost Small denomination time deposits are certificates of deposit with a denomination of less than $100,000 that can only be redeemed at a fixed maturity date without a penalty Saving deposits are non-transaction deposits that can be added to or taken out at any time

Money market deposit accounts similar to money market mutual funds but issued by banks Money market mutual fund shares are retail accounts on which household can write checks Different measures of money tell a different story about course of monetary policy

Reliability of money data: Fed frequently revises earlier estimates of monetary aggregates by large amounts: because small depository institutions need to report the amounts of their deposits only infrequently, the Fed has to estimate these amounts until these institutions provide the actual figures at some future date Second, adjustment of data for seasonal variation is revised substantially as more data become available We should probably not pay much attention to short-term movements in the money supply numbers, but should be concerned only with longer-run movements

Present value: is based on commonsense notion that a dollar paid to you one year from now is less valuable to you than a dollar paid to you today Simple loan: lender provides the borrower with an amount of funds that must be repaid to the lender at the maturity date, along with an additional payment for the interest Interest payment divided by amount of loans is interest rate Shows us that a dollar would not be as valuable to you as it is today because if you had a dollar today you could invest it and end up with more than one dollar in ten years Present value allows us to figure out todays value of a credit market instrument at a given simple interest rate by adding up individual present values of all future payments received

Fixed payment loan: lender provides borrower with an amount of funds, which must be repaid by making the same payment every period consisting of part of the principal and interest for a set number of years (installment loans and mortgages) Coupon bond: pays the owner of the bond a fixed interest payment every year until the maturity date, when a specified final amount is repaid (capital market instruments such as treasury bonds and notes and corporate bonds) Corporation or government agency that issues the bond Maturity date of the bond Bonds coupon rate, the dollar amount of the yearly coupon payment expressed as a percentage of the face value bond

Discount bond: is bought at a price below its face value and the face value is repaid at the maturity date (treasury bills, savings bonds, and long-term zero coupon bonds)

Does not make any interest payments In equation it indicates that for a discount bond, yield to maturity is negatively related to the current bond price

Yield to maturity: interest rate that equates the present value of cash flow payments received from a debt instrument with its value today LOOK AT NOTE CARDS FOR EQUATIONS!!! When coupon bond is priced at its face value, the yield to maturity equals the coupon rate Price of a coupon bond and the yield to maturity are negatively related; that is as the yield to maturity raises, the price of the bond falls. As the yield to maturity falls, price of bond rises Yield to maturity is greater than the coupon rate when the bond price is below its face value

Perpetuity: perpetual bond with no maturity date and no repayment of principal that makes fixed coupon payments of $C forever Coupon bond is like perpetuity because cash flows more than twenty years in the future have such small present discounted values that the value of a longterm coupon bond is very closer to the value of a perpetuity with same coupon rate

Current yield: yearly coupon payment divided by the price of the security used as approximation to describe interest rates on long-term bonds Dollar in the future is not as valuable to you as a dollar today Bond prices and interest rates have inverse relationships

Rate of Return: holding a bond or any security over a particular time period Payments to the owner plus the change in its value Return on a bond will not necessarily equal the yield to maturity on that bond Only bond whose return equals initial yield to maturity is one whose time to maturity is the same as the holding period A rise in interest rates is associated with a fall in bond prices, resulting in capital losses on bonds whose terms to maturity are longer than the holding period The more distant a bonds maturity, the greater the size of the percentage price change associated with an interest-rate change The more distant a bonds maturity, the lower the rate of return that occurs as a result of the increase in interest rate Even though a bond has a substantial initial interest rate, its return can turn out to be negative if interest rate rises RISE IN INTEREST RATE MEANS PRICE OF BOND HAS FALLEN

Maturity and the Volatility of Bond returns:

Prices and returns for long-term bonds are more volatile than those for shorter term bonds

Interest rate risk: riskiness of an assets return that results from interest-rate changes Long-term debt instruments have interest rate risk and short-term do not Bonds with maturity that is as short as the holding period have no interest rate risk because price at the end of the holding period is already fixed at face value

Real interest rate: interest rate that is adjusted by subtracting expected changes in the price level so that it more accurately reflects the true cost of borrowing Adjusted for expected changes in price level Indicates the amount of extra goods and services that we can purchase as a result of holding the security When the real interest rate is lower, there are greater incentives to borrow and fewer incentives to lend

Indexed bonds: interest and principal payments are adjusted for changes in price level Wealth: holding everything else constant, an increase in wealth raises the quantity demanded of an asset Expected returns: an increase in an assets expected return relative to that of an alternative asset, holding everything else unchanged, raises the quantity demanded of the asset Risk: holding everything else constant, if an assets risk rises relative to that of alternative assets, its quantity demanded will fall Risk-averse: does not participate in risky decisions Risk-preferer: loves risk

Liquidity: The more liquid an asset is relative to alternative assets, holding everything else unchanged, the more desirable it is, and the greater will be the quantity demanded Theory of Asset demand: holding all other factors constant Quantity demanded of an asset is positively related to wealth Quantity demanded is positively related to its expected return relative to alternative assets Quantity demanded of an asset is negatively related to the risk of its returns relative to alternative assets Quantity demanded of an asset is positively related to its liquidity relative to alternative assets

Demand curve: lower prices of bond; quantity demanded is higher Supply curve: As price increases, quantity supplied increases

Excess supply: People want to sell more bonds then others can buy, price of bonds will fall Excess demand: people want to buy more bonds then others are willing to sell, price of bonds rise Asset market approach: emphasizes stocks as assets rather than flows Wealth: in a business cycle expansion with growing wealth, demand for bonds rises and demand curve for bonds shifts to the right and in a recession, when income and wealth are falling the demand for bonds falls and demand curve shifts to the left Also if people save more, wealth increases, bond price rises, and demand curve shifts right and vice versa

Expected returns: Higher expected interest rates in the future lower the expected return for long-term bonds, decrease the demand, and shift the demand curve to the left and lower expected interest rates in the future increase the demand for long-term bonds and shift the demand curve to the right Changes in expected returns on stocks expected return on bonds relative to stocks would fall, lowering demand for bonds and shifting demand curve to the left An increase in the expected rate of inflation lowers the expected return for bonds, causing their demand to decline and the demand curve to shift left

Risk: An increase in the riskiness of alternative assets causes the demand for bonds to fall and the demand curve to shift left Liquidity: Increase liquidity of bonds results in an increased demand for bonds and the demand curve shifts to the right, similarly, increase liquidity of alternative assets lowers the demand for bonds and shifts the demand curve to the left Shifts in supply of bonds: Expected profitability of investment opportunities Expected inflation Government budget

Expected profitability of investment opportunities: In a business cycle expansion, the supply of bonds increases and the supply curve shifts to the right and during a recession where are fewer expected profitable investment opportunities, the supply of bonds falls and the supply curve shifts to the left Expected inflation: An increase in expected inflation cases the supply of bonds to increase the supply curve to shift to the right Government budget: Higher government deficits increase the supply of bonds and the shift the supply curve to the right

When expected inflation rises, interest rates rise