Money Management and Investment Strategies

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Questions and Answers

What is the primary reason for holding money as indicated by the transaction motive?

To store wealth long-term

To invest in interest-bearing securities

To earn interest

To facilitate purchases (correct)

If an investor can earn 5 percent on securities, what would happen to the estate's price assuming interest rates on securities increased?

The estate's price would increase

The estate's price would fall (correct)

The estate would be sold for below its capital value

The estate's price would remain the same

What does the nonsynchronization of income and spending refer to?

Income is received in large sums but spent gradually

Income flows exceed spending flows

Income inflows and outflows are mismatched in timing (correct)

Income and spending occur simultaneously

In Jim's monthly checking account strategy, what is the average balance if he deposits his entire paycheck at the start and spends it down to zero by the end of the month?

$600 Signup and view all the answers

If Professor Serebryakov believes selling the estate is beneficial, which factor does he incorrectly assess?

The current interest rate on securities Signup and view all the answers

What happens to the demand for money when interest rates increase?

Demand for money decreases as people invest more in securities Signup and view all the answers

What happens to bond prices and interest rates when they are bid up at price r0?

Bond prices increase and interest rates decrease Signup and view all the answers

What effect does an increase in the supply of money from MS0 to MS1 have on the interest rate?

Lowers the interest rate from 7 percent to 4 percent Signup and view all the answers

What would an investor consider when deciding between holding cash or investing in securities?

The interest rate on alternative investments Signup and view all the answers

Which scenario best illustrates the transaction motive for holding money?

Keeping cash on hand for groceries throughout the month Signup and view all the answers

How does an increase in nominal income affect the money demand curve?

Shifts it rightward, increasing interest rates Signup and view all the answers

What consequence does the Federal Reserve face when interest rates approach zero?

They cannot lower rates below zero, limiting further action Signup and view all the answers

What is one primary tool the Central Bank uses to change the interest rate?

Increasing or decreasing the money supply Signup and view all the answers

At what point did the Fed keep the short-term interest rate close to zero?

Mid-2008 Signup and view all the answers

What happens to the equilibrium interest rate when the money demand curve shifts rightward?

It increases Signup and view all the answers

What important topic was indicated to be discussed in the next chapter?

The factors that determine the aggregate price level Signup and view all the answers

What characterizes easy monetary policy?

Lower interest rates to encourage borrowing Signup and view all the answers

What is the primary function of the Federal Funds Rate?

Indicates the rate banks pay to borrow reserves from each other Signup and view all the answers

Which interest rate is considered a benchmark that banks often use for quoting interest rates?

Prime Rate Signup and view all the answers

According to the expectations theory, how is the 2-year interest rate determined?

It averages current and future short-term rates Signup and view all the answers

What is the relationship between market-determined prices of existing bonds and interest rates?

They are inversely related. Signup and view all the answers

What does the term 'nonsynchronization of income and spending' imply?

There is a mismatch between income generation and expenditure Signup and view all the answers

What is a key characteristic of the Three-Month Treasury Bill Rate?

It is a widely followed short-term interest rate Signup and view all the answers

What is referred to as the fixed yearly payment offered by bonds?

Coupon Signup and view all the answers

Which type of bond carries the least risk and earns the AAA Corporate Bond Rate?

Bonds issued by highly rated companies Signup and view all the answers

How is the interest rate, or yield, on a bond calculated?

Using the bond's market price, face value, maturity, and coupon. Signup and view all the answers

What must accompany a bond for it to have a fixed yearly payment?

A maturity date Signup and view all the answers

What is the typical relationship between the maturity of bonds and their interest rates?

Bonds of different maturities have varying interest rates Signup and view all the answers

What is the face value of a bond typically denominated in?

$1,000 Signup and view all the answers

What does the term 'interest' refer to in financial markets?

The fee that borrowers pay to lenders for fund usage Signup and view all the answers

Which of the following statements about bonds is FALSE?

Bonds do not have maturity dates. Signup and view all the answers

What impact does a change in the market price of a bond have on its interest rate?

Lower prices lead to higher interest rates. Signup and view all the answers

What happens to the demand for cash when the interest rate on checking accounts increases?

Demand for cash decreases Signup and view all the answers

What is the effect of an increase in nominal aggregate output on the money demand curve?

It shifts the money demand curve to the right Signup and view all the answers

How is the equilibrium interest rate determined in the economy?

By the equality of quantity of money demanded and quantity of money supplied Signup and view all the answers

If most ATM machines increase their transaction fees, what impact is likely to have on transaction demand for money?

Transaction demand for money will decrease Signup and view all the answers

What leads to a movement along the money demand curve?

A change in the interest rate Signup and view all the answers

Which factor shifts the money demand curve to the right?

An increase in real aggregate output Signup and view all the answers

What can cause the demand for cash to become less responsive?

A decrease in checking account interest rates Signup and view all the answers

What relationship exists between the quantity of money demanded and the interest rate?

They are inversely proportional Signup and view all the answers

What is the average money holding when the number of switches is 1 and the interest rate is 3 percent?

$300.00 Signup and view all the answers

Which of the following represents the net profit when there are 4 switches at an interest rate of 5 percent?

$16.00 Signup and view all the answers

What is the cost of switching from bonds to money per transaction?

$2.00 Signup and view all the answers

What is the average bond holding when the number of switches is 3 at an interest rate of 5 percent?

$450.00 Signup and view all the answers

Which option correctly identifies the average money holding with 2 switches at an interest rate of 3 percent?

$200.00 Signup and view all the answers

What is the interest earned when there are 2 switches at an interest rate of 5 percent?

$22.50 Signup and view all the answers

Identify the net profit for 3 switches at an interest rate of 0.03.

$7.50 Signup and view all the answers

What is the net profit when there are 4 switches at an interest rate of 3 percent?

$14.40 Signup and view all the answers

Study Notes

Principles of Economics Eleventh Edition

This is a textbook for a principles of economics course.
It has multiple authors: Karl E. Case, Ray C. Fair, and Sharon M. Oster.
The publication is a global edition.
The copyright is held by Pearson Education Inc.
The book is protected by US copyright laws and is for instructor use only.
Dissemination or sale of the book is not permitted.
Students should only access the material through their instructor in the classroom.

Money Demand and Equilibrium Interest Rate

This chapter covers the demand for money and how the equilibrium interest rate is determined.
It discusses interest rates and bond prices.
The chapter outlines the transaction motive, speculation motive, and total demand for money.
It explains how nominal income affects demand for money.
The concept of a zero interest rate bound is introduced.

Interest Rates and Bond Prices

Interest is the fee borrowers pay lenders for using funds.
Firms and governments issue bonds, paying interest to bondholders.
Bonds have a face value (typically $1,000), maturity date, and a fixed yearly payment (coupon).
Market-determined bond prices and interest rates are inversely related.
Interest rates are determined by the bond market.

Professor Serebryakov's Economic Error

Professor Serebryakov, a character in a Chekhov play, makes an economic error in his reasoning regarding estate values.
Serebryakov proposes selling an estate yielding only 2% and investing in securities paying 4-5%, but forgets about the inverse relationship between bond price and interest rates.

The Demand for Money

Money demand refers to how much of a person's financial assets are in the form of money (which doesn't yield interest), versus interest-bearing securities (bonds).
The transaction motive is a key reason people hold money is to buy things.
The nonsynchronization of income and spending refers to the mismatch between when income is received and when expenses are incurred.

The Total Demand for Money

The total quantity of money demanded in an economy is the sum of cash and checking account demands for both households and firms.
Demand for money is limited by transactions and everyday spending.
The opportunity cost of holding money, measured by the interest rate, determines the quantity of money demanded.

ATMs and the Demand for Money

Italy provides a case study on how ATMs affect the demand for money.
ATM use in Italy shows an inverse relationship between interest rates and cash holdings. - When interest rates on checking accounts rise, people use ATMs less frequently, and hold less cash, and keep more money in their accounts.

The Effect of Nominal Income on the Demand for Money

An increase in nominal income (P⋅Y) shifts the money demand curve to the right.

The Equilibrium Interest Rate

The equilibrium interest rate is the rate at which the quantity of money demanded equals the quantity supplied.

Supply and Demand in the Money Market

Equilibrium exists when the supply of money equals the demand for money, and supply of bonds equals demand for bonds.
Equilibrium is shown by a point on the graph where money supply and demand intersect.

Changing the Money Supply to Affect the Interest Rate

An increase in the money supply lowers the interest rate.

Increases in P•Y and Shifts in the Money Demand Curve

Increases in nominal income (P⋅Y) shift the money demand curve rightward, raising the equilibrium interest rate.

Zero Interest Rate Bound

During the 2008 financial crisis, the US Federal Reserve (Fed) lowered the short-term interest rate near to zero.
The interest rate cannot fall below zero, thus limits the Fed's ability to further stimulate the economy.

Looking Ahead

This chapter's purpose was to explain how central banks adjust interest rates and money supply via open market operations.
The determination of the aggregate price level, and why central banks change interest rates, are topics for the upcoming chapters.

Review Terms and Concepts

Keywords and concepts from the chapter, including monetary policy (easy and tight), transaction motive, speculation motive, interest, and income/spending nonsynchronization.

Chapter 11 Appendix A: The Various Interest Rates in the U.S. Economy

This appendix examines different interest rates in the US economy.
The term structure of interest rates refers to the relationship among interest rates offered on various loan terms (maturities).
The expectations theory of the term structure of interest rates equates the 2-year rate to the average of current and future 1-year rates.
Fed actions can influence expectations and long-term rates.

Chapter 11 Appendix B: The Demand for Money—A Numerical Example

This appendix illustrates money demand and the impact of interest rates in a numerical example.
It presents numerical data for optimal money holdings and interest rates in a 2-column table.

Studying That Suits You

Use AI to generate personalized quizzes and flashcards to suit your learning preferences.

Description

This quiz explores concepts of money management, including the transaction motive for holding cash, the impact of interest rates on estate prices, and strategies for managing checking account balances. It also delves into the relationship between money supply and interest rates, as well as decision-making for investors between cash and securities.