BUS614 Study Guide

Unit 3: Money and Bond Markets

3a. Describe the dynamics that define interest rates in debt markets, such as central banks, commercial banks, and maturity rates 

  • How are interest rates defined?
  • How would you describe the Yield Curve?

Interest Rates 

Interest rates are generally connected to money supply and money demand. When the money supply falls, the equilibrium interest rates increase. Similarly, when price levels decrease, the equilibrium interest rates also fall. Finally, when real GDP falls, the equilibrium interest rates fall. Money supply and money demand will equalize only at one average interest rate. The equilibrium interest rate in the economy is the rate that equalizes money supply and money demand.

Normally, a reduction in the interest rate increases the quantity of money demanded, whereas an increase in the interest rate reduces the quantity of money demanded. Therefore, a shift in money demand or supply will lead to a change in the equilibrium interest rate and changes in the real GDP and the price level.

To review, see Interest Rate Determination and Demand, Supply, and Equilibrium in the Money Market.

Yield Curve 

The Yield Curve shows interest rates across different contract lengths for similar debt contracts. It shows the relationship between interest rate levels and the time to maturity. Generally, the Yield Curve could either be flat, humped, or inverted. A flat yield curve sends signals of uncertainty in the economy and happens when all maturities have similar yields. A humped curve happens when short-term and long-term yields are equal and medium-term yields are higher than those of the short-term and long-term. Finally, an inverted yield curve happens when long-term yields fall below short-term yields.

To review, see More on Interest Rates.

 

3b. Compare money markets and bond markets by examining the terms of the debts they contain 

  • What is the difference between money markets and bond markets?

Generally, both money markets and bond markets are regarded as fixed-income securities, rendering them liquid, accessible, and safe investments. Money markets handle short-term debt securities that typically take less than a year to mature, rendering them cash investments. In contrast, bond markets have a longer maturity and are riskier than money markets. In terms of maturity, bonds can be short-term, long-term, or medium-term. Comparing both short-term bonds with money markets' maturity, it can be noted that short-term bonds are typically between 1-3 years, unlike money markets where their short-term means typically require less than a year to mature.

To review, see Bonds and Bond Markets.

 

3c. Differentiate between domestic bonds, Eurobonds, and foreign bonds

  • What are the different types of bonds?

Generally, there are domestic bonds, foreign bonds, and what is referred to as Eurobonds. Domestic bonds are those issued in a particular country using that country's currency. Governments and corporations can issue domestic bonds in a particular country. On the other hand, foreign bonds are those issued by foreign issuers dominated by the currency of the national market where the bonds are issued. For example, a British company may decide to issue bonds in the United States dominated by US dollars and sell to US investors. Finally, Eurobonds are issued outside the issuer's country and sold to investors across the globe. For example, a US company may issue US dollar-denominated bonds and sell them to British investors.

To review, see Types of Bonds.

 

Unit 3 Vocabulary

This vocabulary list includes the terms that you will need to know to successfully complete the final exam.

  • Money Supply
    • The money supply is the amount of currency currently in circulation and the total value of all checking accounts in banks.
  • Money Demand
    • Money demand is the demand by households, businesses, and the government for highly liquid assets such as currency and checking account deposits.
  • Money Market Model
    • The money market model is an economic model that describes the supply and demand for money in a particular country.
  • Equilibrium Interest Rate
    • It refers to the rate at which the quantity of money demanded is equal to the quantity of money supplied.
  • Heath-Jarrow-Morton Framework
    • This is an approach by which predicting future interest rates is possible.
  • Liquidity
    • Liquidity is a term used to describe the distinction between bonds and currency.
  • Yield Curve
    • A yield curve shows the relationship between interest rate levels (or cost of borrowing) and the time to maturity.
  • Real GDP
    • Real GDP is the total value of all final goods and services produced during a particular year or period, adjusted to eliminate the effects of price changes.
  • Financial Stress Index
    • It is the rate of difference between a 10-year treasury bond rate and a 3-month Treasury bond rate.
  • Eurobonds
    • US dollar-denominated bond issued by a non-U.S. (European) entity.
  • Foreign Bonds
    • It is issued by foreign issuers dominated by the currency of the national market where the bonds are issued.
  • Domestic Bonds
    • It is issued in a particular country using the currency of that country.
  • Yankee Bonds
    • A US dollar-denominated bond issued by a non-U.S. entity in the US market.
  • Bulldog Bonds
    • A pound-sterling-denominated bond issued in England by a foreign institution or government.
  • Samurai Bonds
    • A Japanese yen-denominated bond issued by a non-Japanese entity in the Japanese market.
  • Kangaroo Bonds
    • An Australian dollar-denominated bond issued by a non-Australian entity in the Australian market.
  • Kimchi Bonds
    • A Korean won-denominated bond issued by a non-Korean entity in the Korean market.