Financial Markets and Money: Functions, Valuation, and Investment, Study notes of Banking and Finance

Download Financial Markets and Money: Functions, Valuation, and Investment and more Study notes Banking and Finance in PDF only on Docsity! Review Session -Midterm 1 • Review Quiz 1 • Chapter 5 & 6 end-of-chapter problems • Review Chapter 1-6 Function of Financial Intermediaries: Indirect Finance • Lower transaction costs (time and money spen t in carrying out financial transactions). – Economies of scale – Liquidity services • Reduce the exposure of investors to risk – Risk Sharing (Asset Transformation) – Diversification Functions of Money • Medium of Exchange: – Eliminates the trouble of finding a double coincidence of n eeds (reduces transaction costs) – Promotes specialization • A medium of exchange must – be easily standardized – be widely accepted – be divisible – be easy to carry – not deteriorate quickly Functions of Money • Unit of Account: – used to measure value in the economy – reduces transaction costs • Store of Value: – used to save purchasing power over time. – other assets also serve this function – Money is the most liquid of all assets but loses val ue during inflation Consol or Perpetuity • A bond with no maturity date that does not repay principal but p ays fixed coupon payments forever consol theofmaturity toyield paymentinterest yearly consol theof price /     c c c i C P iCP cc PCi /: thisasequation above rewritecan  For coupon bonds, this equation gives the current yield, an easy to calculate approximation to the yield to maturity Fisher Equation = nominal interest rate = real interest rate = expected inflation rate When the real interest rate is low, there are greater incentives to borrow and fewer incentives to lend. The real inter e r r e i i i i     est rate is a better indicator of the incentives to borrow and lend. Theory of Asset Demand 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 r eturn 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 rel ative to alternative assets Summary Table 3 Factors That Shift the Supp ly of Bonds Summary Table 4 Factors That Shift the Demand for an d Supply of Money Expectations Theory (cont’d) 2 1 1 2 Both bonds will be held only if the expected returns are equal 2 2 The two-period rate must equal the average of the two one-period rates For bonds with longer maturities e t t t e t t t t t nt i i i i i i i i i          1 2 ( 1)... The -period interest rate equals the average of the one-period interest rates expected to occur over the -period life of the bond e e e t t ni i n n n     