Lecture Slides on Money and Financial Markets | ECON 1, Study notes of Economics

Download Lecture Slides on Money and Financial Markets | ECON 1 and more Study notes Economics in PDF only on Docsity! <file> 1 Oct. 30th, 2002 ECON 1 – Section 17 – Page 1 GSI: R. Estopina ECON 1 – Section 17 Money and Financial Markets. ECON 1 – Section 17 – Page 2 GSI: R. EstopinaOct. 30th, 2002 Contact Details GSI: Ramon Estopina Office Hours: Thursday 1:45-3:00 PM Office: Evans 508-7 Email: estopina@haas.berkeley.edu Handouts (only sections 104 & 133) after class in: http://www.ocf.berkeley.edu/~jaychen/econ1/ Please read: Read before downloading!. ECON 1 – Section 17 – Page 3 GSI: R. EstopinaOct. 30th, 2002 Section 17 Agenda Administrative Stuff (1 min) Recap Quiz (5 min) PS#3 Q4 & Q5 (10 min) Exercise 23.1 (5 min) Problem 23.1 (5 min) Example 23.3 (5 min) Problem 23.3 (5 min) Problem 26.3 (10 min) Re-cap (2 min) ECON 1 – Section 17 – Page 4 GSI: R. EstopinaOct. 30th, 2002 Review of Last Lecture - 10/28th Chapter 23 & 26: Money: Definitions & Uses (M1 in Econ 1, unless stated otherwise) Fractional Reserve Banking (required reserve ratio, excess reserves) Stocks (expected return on dividends & capital gains, risk premium) Bonds (Coupon rate, Inverse Relation between bond price & current interest rate) Creation of Money (multiplier) Money Demand Macro factors (i, Y, P) Demand curve (movement along, shift) Foreign holdings ECON 1 – Section 17 – Page 5 GSI: R. EstopinaOct. 30th, 2002 Important to remember: Everything in previous slide !!! Mainly: M1 & M2 Stocks & Bonds Money Supply & Demand We do not have an equation of the day today. ECON 1 – Section 17 – Page 6 GSI: R. EstopinaOct. 30th, 2002 Recap Quiz - 1 A coupon payment is: 1) the repayment of a debt, including both principle and interest. 2) equal to the amount originally lent through a bond. 3) the interest rate promised when a bond is issued. 4) a regular interest payment made to a bondholder. 5) the payment made when a bond is sold at a discount. <file> 2 ECON 1 – Section 17 – Page 7 GSI: R. EstopinaOct. 30th, 2002 Recap Quiz - 2 A regular payment made to a partial owner of a firm is called a(n): 1)equity. 2)stock. 3)coupon payment. 4)dividend. 5)interest payment. ECON 1 – Section 17 – Page 8 GSI: R. EstopinaOct. 30th, 2002 Recap Quiz - 3 Money refers to: 1)dollars and coins. 2) currency an checks. 3)any asset that can be used to make purchases. 4) currency, checks, and stocks. 5)any asset or liability. ECON 1 – Section 17 – Page 9 GSI: R. EstopinaOct. 30th, 2002 Recap Quiz - 4 Cash or similar assets held by banks for the purpose of meeting depositors withdrawls and payments are knows as 1) bank reserves. 2) fractional reserves. 3) deposit reserves. 4) the reserve/deposit ratio. 5) excess reserves ECON 1 – Section 17 – Page 10 GSI: R. EstopinaOct. 30th, 2002 Recap Quiz - 5 Which of the following does NOT affect the demand for money? 1) the nominal interest rate 2) real income 3) the price level 4) real output 5) the supply of money ECON 1 – Section 17 – Page 11 GSI: R. EstopinaOct. 30th, 2002 Recap Quiz - 6 Your decision about the form in which to hold your wealth is your 1)demand for money. 2)portfolio allocation decision. 3) stock portfolio. 4) estate plan. 5)asset balance plan. ECON 1 – Section 17 – Page 12 GSI: R. EstopinaOct. 30th, 2002 PS#3 – Question 4 Consider an economy with NX=0. Hence in equilibrium, S = I. State how each affects the Savings and Investment equilibrium. <file> 5 ECON 1 – Section 17 – Page 25 GSI: R. EstopinaOct. 30th, 2002 … & Stocks (not fish stocks) Claim to partial ownership of a firm. Stockholders receive two types of return: Capital gains (losses): price of stock increases (decreases) Annual dividends (may be zero) Stock price reflects: Expected prospects of firm (expected capital gains and dividends) Interest rate (opportunity cost) Higher r => lower stock prices: money flows to bonds Risk (requires higher return) risk premium: additional rate of return required to hold risky asset compared to safe asset. ECON 1 – Section 17 – Page 26 GSI: R. EstopinaOct. 30th, 2002 Example 23.3 (F&B page 613) Suppose AB Corp. is expected to pay $1 dividend and have a market price of $80 a share in 1 year. Interest rate in Gov. bonds is 6% annual. As AB Corp shares are risky, you require higher return than safe gov. bonds. You require a 4% risk premium, so your expected return for AB Corp shares is 10%. ECON 1 – Section 17 – Page 27 GSI: R. EstopinaOct. 30th, 2002 Example 23.3 (Conclusion) What is the most you will be willing to pay for the stock now? If you sell the share in 1 year you’ll make $81 (Div + Price) Your required return is 10%. Remember: PV = M/(1+i)t M=81 / i=10%=0.1 / t=1 PV = $73.64 As financial investors dislike risk, they require a low price for risky assets like stocks. ECON 1 – Section 17 – Page 28 GSI: R. EstopinaOct. 30th, 2002 Problem 23.3 (F&B page 632) Your financial investment consist of: US Gov. bonds maturing in 10 years Shares in a start-up doing research in pharmaceuticals. How would you expect the following news to affect the value of your assets? ECON 1 – Section 17 – Page 29 GSI: R. EstopinaOct. 30th, 2002 Problem 23.3 (cont’d) A) Interest rates on newly issued government bonds rise. Both bond and stock prices fall. B) Inflation is forecasted to be much lower than previously expected. Remember Fisher Effect: Inflation and nominal interest rates move together. Lower inflation implies lower interest rates, which raise the value of both the bonds and the stocks. ECON 1 – Section 17 – Page 30 GSI: R. EstopinaOct. 30th, 2002 Problem 23.3 (cont’d) Now assume interest rates in newly issued gov bonds remain unchanged. C) Large swings in the stock market increase financial investors’ concerns about market risk. Increased risk premium lowers the stock price. Bond price unchanged. D) A company whose stock you own announces the development of a valuable new drug. However, the drug will not come to market for at least 5 years. Increased future dividends raise the current stock price. <file> 6 ECON 1 – Section 17 – Page 31 GSI: R. EstopinaOct. 30th, 2002 Problem 23.3 (Conclusion) E) The same company announces that it will not pay a dividend next year. If financial investors previously expected the company to pay a dividend, this news will reduce the stock price. F) The Federal gov announces a system of price controls on prescription drugs. The likely reduction in future profits and dividends by the pharmaceutical company lowers its current stock price. ECON 1 – Section 17 – Page 32 GSI: R. EstopinaOct. 30th, 2002 Demand for Money When will you hold money? Remember: MB – MC > 0. You took Micro- economic classes, didn’t you? Benefit of holding money Make transactions Value of transactions depends on: real income or output (Y) price level (P) nominal GDP (P*Y) Costs of holding money Opportunity costs: nominal interest rate (i) ECON 1 – Section 17 – Page 33 GSI: R. EstopinaOct. 30th, 2002 Problem 26.3 (F&B page 719) How do you expect each of the following to affect the US demand for money? A) Competition among brokers forces down the commission charge for selling holdings of bonds or stocks. Lower commission charges reduce the cost of converting non-money assets into money (increase liquidity). People will tend to hold less money, knowing that it is relatively cheap to sell other assets to obtain money as needed to make transactions. So the economy-wide demand for money declines. ECON 1 – Section 17 – Page 34 GSI: R. EstopinaOct. 30th, 2002 Problem 26.3 (cont’d) B) Grocery stores begin to accept credit cards in payment. Now people can charge their groceries instead of using money (cash or check). But the overall effect is likely to be to reduce the amount of money people need to hold on average over the month. The demand for money declines. C) Financial investors become concerned about increasing riskiness of stocks. If stocks become more risky, people will demand relatively more safe assets, money among them. The demand for money rises. ECON 1 – Section 17 – Page 35 GSI: R. EstopinaOct. 30th, 2002 Problem 26.3 (cont’d) D) Online banking allows customers to check balances and transfer funds between checking and mutual fund investments 24 hours a day. Mutual fund investments are not part of the M1 money stock (they are part of M2, and I’m not talking about BMW’s here). As in part a, if people can conveniently and cheaply convert non-money assets into money as needed for transactions, they can get by holding less money on average. The demand for money declines. ECON 1 – Section 17 – Page 36 GSI: R. EstopinaOct. 30th, 2002 Problem 26.3 (Conclusion) E) The economy enters a boom period. Higher income raises the volume of transactions. The demand for money increases. F) Political instability increases in developing nations. Worried about inflation or even confiscation of their domestic assets, citizens of developing nations may choose to hoard dollars. The total demand for U.S. money (including the overseas demand) rises. <file> 7 ECON 1 – Section 17 – Page 37 GSI: R. EstopinaOct. 30th, 2002 Problems for next sections !!! For next section: Chapter 24: 4. Remember: This is not mandatory. It won’t be graded. Only for those of you that need improvement in Exam grades. ECON 1 – Section 17 – Page 38 GSI: R. EstopinaOct. 30th, 2002 Midterm Survey – GSI / Section !!! Reminder: Fill the online survey. Only 18 responded. Today is last day !! Go to our website for the link http://www.ocf.berkeley.edu/~jaychen/econ1/ It won’t take more than 5 min. No names needed, but please only sections 104 and 133. ECON 1 – Section 17 – Page 39 GSI: R. EstopinaOct. 30th, 2002 Next class Next Class: Section 18 – Monday, Nov 4th If you want more practice, work on Next Sections Problems. Read ch. 24 & 25. LAST OPPORTUNITY TO FILL THE SURVEY ONLINE!!!!. You can download handouts this afternoon. Thank you for coming on time !!! Enjoy the Weekend !!.