Economics - Money Demand Concepts
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Questions and Answers

What is the primary reason individuals hold money for transactions?

  • To invest in stocks
  • As a medium of exchange for everyday transactions (correct)
  • To generate interest income
  • To save for retirement

    • Precautionary demand for money is positively related to interest rates.

    False

    What are the three motives for holding money according to Keynes?

    Transactions motive, precautionary motive, speculative motive

    In the speculative motive, money serves as a __________ of wealth.

    <p>store</p> Signup and view all the answers

    Match each motive for holding money with its description:

    <p>Transactions Motive = Medium of exchange for daily transactions Precautionary Motive = Cushion against unexpected wants Speculative Motive = Store of wealth Demand for money = Varies with changes in income and interest rates</p> Signup and view all the answers

    What term describes the decline in the demand for money relative to income as payment technology advances?

    <p>Payment technology impact</p> Signup and view all the answers

    Nominal quantities of money are the same as real quantities of money.

    <p>False</p> Signup and view all the answers

    If the money supply is 2 trillion and the aggregate output is 10 trillion with a velocity of 5, what is the price level?

    <p>1</p> Signup and view all the answers

    Doubling the money supply results in a doubling of the price level.

    <p>True</p> Signup and view all the answers

    The precautionary motive for holding money is similar to the __________ motive.

    <p>transaction</p> Signup and view all the answers

    What does the equation  = %M + %V − %Y represent?

    <p>The inflation rate.</p> Signup and view all the answers

    If the aggregate output is growing at 3% per year and the growth rate of money is 5%, the inflation rate is ___%.

    <p>2</p> Signup and view all the answers

    Match the components of the equation to their meanings:

    <p>M = Money supply growth rate V = Velocity of money P = Price level growth rate Y = Aggregate output growth rate</p> Signup and view all the answers

    With a money supply of 4 trillion, an aggregate output of 10 trillion, and a velocity of 5, what is the new price level?

    <p>2</p> Signup and view all the answers

    If the velocity of money is constant, it has a growth rate of zero.

    <p>True</p> Signup and view all the answers

    What is the formula for the quantity theory of money in terms of inflation?

    <p>π = %ΔM − %ΔY</p> Signup and view all the answers

    How is the demand for real money balances related to interest rates?

    <p>Negatively related</p> Signup and view all the answers

    Higher income levels tend to decrease the demand for real money balances.

    <p>False</p> Signup and view all the answers

    Name one asset that individuals may hold as part of their overall portfolio.

    <p>Money</p> Signup and view all the answers

    As interest rates rise, the demand for real money balances tends to ______.

    <p>fall</p> Signup and view all the answers

    Match the factors affecting the demand for money with their effect:

    <p>Interest rates = Negatively affects demand Income = Positively affects demand Wealth = Positively affects demand Liquidity of other assets = Negatively affects demand</p> Signup and view all the answers

    Which theory supports the idea that the demand for real money balances is positively related to income?

    <p>Portfolio Theory</p> Signup and view all the answers

    The expected return on money changes as interest rates rise.

    <p>False</p> Signup and view all the answers

    What is one consequence of higher interest rates on money relative to bonds?

    <p>Money becomes less desirable.</p> Signup and view all the answers

    What formula is used to calculate the Present Value (PV) of cash flows?

    <p>PV = CF / (1 + i)^n</p> Signup and view all the answers

    A coupon bond pays interest payments periodically until maturity.

    <p>True</p> Signup and view all the answers

    What does the term 'yield to maturity' primarily refer to?

    <p>The most accurate measure of interest rates</p> Signup and view all the answers

    What is the cash flow (CF) in two years for the calculation provided?

    <p>250</p> Signup and view all the answers

    A dollar paid to you in the future is considered to be more valuable than a dollar paid today.

    <p>False</p> Signup and view all the answers

    A ______ bond is also known as a zero-coupon bond.

    <p>discount</p> Signup and view all the answers

    Match the following credit market instruments with their descriptions:

    <p>Simple Loan = Amount repaid at maturity with interest. Fixed Payment Loan = Repayment in equal installments over time. Coupon Bond = Fixed interest payments until maturity. Discount Bond = Bought at discount, repaid at face value.</p> Signup and view all the answers

    What is the formula to calculate the present value?

    <p>PV = CF / (1 + i)^n</p> Signup and view all the answers

    In a fixed payment loan, how are the repayments structured?

    <p>Fixed amounts repaid periodically including principal and interest.</p> Signup and view all the answers

    In one year, $100 with an interest rate of 10% will amount to ______.

    <p>$110</p> Signup and view all the answers

    Discount bonds pay periodic interest payments to the bondholder.

    <p>False</p> Signup and view all the answers

    Match the following terms with their definitions:

    <p>Present Value = The current worth of a future sum of money Future Cash Flow = Payments expected in the future Interest Rate = The percentage charged on borrowed money Yield to Maturity = The total return anticipated on a bond if held until it matures</p> Signup and view all the answers

    What is the annual interest rate (i) used in the Present Value calculation?

    <p>0.15</p> Signup and view all the answers

    The cash flows from different debt instruments can have the same timing and amounts.

    <p>False</p> Signup and view all the answers

    What is the first step to working backward from future amounts to the present?

    <p>Use the present value formula.</p> Signup and view all the answers

    What does the nominal interest rate represent?

    <p>Interest rate before considering inflation</p> Signup and view all the answers

    A real interest rate of 4% means that the purchasing power has increased by 4%.

    <p>False</p> Signup and view all the answers

    What is the Fisher Equation used for?

    <p>To calculate nominal and real interest rates.</p> Signup and view all the answers

    The lender earned $8 on the $100 loan, but due to an inflation rate of 5%, the real increase in purchasing power was only $____.

    <p>3</p> Signup and view all the answers

    What happens to borrowing incentives when the real interest rate is low?

    <p>Incentives to borrow increase</p> Signup and view all the answers

    An increase in an individual's wealth does not affect the demand for assets.

    <p>False</p> Signup and view all the answers

    What is the expected outcome when inflation is higher than the nominal interest rate?

    <p>Real interest rate becomes negative.</p> Signup and view all the answers

    Study Notes

    Introduction

    • This document appears to be study notes for a course on money and banking.
    • It covers various topics, including financial markets, financial institutions, monetary policy, and international finance.
    • The notes are designed to be easy to digest and understand, focusing on key concepts and details.

    Chapter 1: Why study Money, Banking and Financial Markets?

    • Financial markets transfer funds from surplus to deficit entities.
    • They promote economic efficiency.
    • Well-functioning markets lead to high economic growth.
    • Poorly functioning markets hinder economic growth.
    • Bond markets (and interest rates) are important to economic activity
    • They enable corporations and governments to borrow funds
    • Interest rates represent the cost of borrowing

    Chapter 2: An Overview of the Financial System

    • Direct finance: borrowers borrow directly from lenders in financial markets (by selling securities).
    • Indirect finance: borrowers borrow through intermediaries (banks, etc), channeling funds from savers to borrowers.
    • Financial markets allocate capital, increasing production.
    • Well-functioning markets result in better consumer choices.
    • Financial markets are increasingly integrated globally.
    • Function of financial markets is to channel funds
    • Direct finance involves people borrowing directly from lenders in financial markets
    • Indirect finance involves intermediaries borrowing funds from lenders
    • Well functioning financial market promotes economic efficiency by producing efficient allocation of capital.

    Chapter 3: What is Money?

    • Money is anything generally accepted as payment for goods and services or to repay debts.
    • Functions of money: medium of exchange, unit of account, store of value. -Types of money:
      • Commodity money: made from precious metals
      • Fiat money: paper currency issued by the government
      • Checks: instructions for transferring funds
      • Electronic money (e-money)
    • Money supply (M1 and M2): M1 (most liquid forms of money); M2 includes M1 plus other assets
    • Monetary aggregates: tools to measure money supply (e.g., M1 and M2)

    Chapter 4, Part 1: Quantity Theory, Inflation, and the Demand for Money

    • Quantity theory of money: money supply, price level, and aggregate output are related
    • Equation of Exchange: MV = PY (Money supply x Velocity = Price level x Output)
    • Velocity of money: the number of times a unit of currency is used in a given period
    • The quantity theory suggests that changes in the money supply directly affect the price level and nominal income.
    • The equation can be modified to show the relationship between inflation and money growth

    Chapter 4, Part 2: Quantity Theory, Inflation, and the Demand for Money

    • Keynesian liquidity preference theory's 3 money demand motives: transactions, precautionary, speculative.
    • People hold money for transactions, in case of emergencies (precautionary), and for anticipated changes in interest rates (speculative).
    • Portfolio choice theory: the quantity of money demanded is related to wealth, the rate of return between assets, the risk of the assets and the assets liquidity.

    Chapter 5: The Meaning and Behavior of Interest Rates

    • Interest rates are the cost of borrowing money.
    • Present value: the current worth of a future sum of money.
    • Calculating yield to maturity: determining the interest rate that equates the present value of future cash flows to the current market price of an asset
    • Real interest rates account for inflation

    Chapter 6, Part 1 & 2: Banking and the Management of Financial Institutions

    • Bank balance sheets list assets and liabilities.
    • Assets (loans, securities, reserves), liabilities (deposits, borrowing).
    • Banks make profit by earning interest on assets higher than their liability costs.
    • Asset, Liability & Capital Adequacy Management principles help banks to maximize profit, reduce risk, and maintain liquidity
    • The role of reserves, which include required reserves (based on regulatory requirements), and excess reserves
    • Credit risk, adverse selection, and moral hazard, screening and monitoring, loan commitments, and compensating balances.

    Chapter 7: Central Banks

    • Central banks control the money supply in the economy.
    • A central bank can print notes and coins, hold reserves for other banks, supervise banks, and manage public debt.
    • Central banks are involved in managing monetary policy and maintaining financial stability
    • Central Banks operate as "bankers' banks"

    Chapter 8: Tools of Monetary Policy

    • Tools used by central banks to control money supply and interest rates: Open market operations, discount lending, and reserve requirements.
    • Open market operations: buying and selling of securities, affecting the money supply and interest rates
    • Discount policy and lender of last resort: loans to commercial banks during emergencies
    • Reserve requirements: regulation on the portion of deposits banks must hold in reserve.

    Chapter 10: Financial Crises

    • Financial crises are characterized by sharp declines in asset prices and failures of financial institutions.
    • The stages include: credit booms and busts, banking crises, and debt deflation
    • Global financial crisis of 2007-2009: caused by subprime mortgages, housing price bubbles, and financial innovations.
    • Results: sharp declines in asset values, bank failures. and major recessions.

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    Money, Banking, and Financial Markets: PDF

    Description

    Test your understanding of the motives for holding money as discussed in Keynesian economics. This quiz covers transaction, precautionary, and speculative demands for money, along with related concepts such as the relationship between money and interest rates. Challenge yourself with questions about money supply, velocity, and inflation rates.

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