Central Banks/Monetary Policy

• equity - finance through the issue of new shares and repaid through dividends
• debt (bond) - borrowed money repaid with interest
• maturity - the year the debt is fully repaid
• Coupon - fixed rate of payment received by the holder of a bond, until maturity
• default risk - possibility that issuer will not be able to pay back the loan or coupons on time
• Yields - rate of interest

  • coupon rate/ market price x100
  • if yield>interest rate - hold, vice versa
• • if price of a government bond goes up, yield goes down - coupon rate is smaller
  • if price of a government bond goes down, yield goes up - coupon rate is larger
• Central Bank - controls monetary policy through interest rates, money supply and exchange rates to keep inflation low and sustainable
• Loanable funds theory - interest rates are set by borrowers and savers of an economy
• Liquidity preference theory - investors should demand a higher interest rates on securities that are long term, that carry greater risk
• Lender of last resort - if a bank experiences liquidity problem, they can turn to the central bank to sell their illiquid assets or take a short term loan. This can lead to a moral hazard
• Central banks: Act as a banker for the government - selling/buying gov bonds to influence budget
• Central bank most likely won't bail a bank if they go insolvent - engage in risky deals
• Moral Hazard - when a risk is taken, the externalities are taken on a third party
• Forward guidance - The Bank of England can give a clear indication of future interest rates allowing for markets to adjust.
• Central banks can reduce interest rates by buying bonds, and vice versa
• Quantitative easing - Increasing the amount of money in circulation through open market operations
• Quantitative tightening - is the process of reducing the money supply by buying government bonds.
• Zero Lower Bound (ZLB): when interest rates are close to 0, it can cause a liquidity trap limiting the effects of monetary policy on growth
• Liquidity trap: when people anticipate deflation and thus, hold their money in hopes for cheaper prices
• Dispositional effect - refers to the tendency for investors to sell assets that have increased in value, and hold assets that have decreased in value.
• Quantity Theory of Money - The general price level of goods and services is proportional to the money supply in an economy
• Financial Accelerator -developments in financial markets amplify the effects of changes in the economy