ECON 295 Lecture 11: Macro Lecture 11

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For simplicity, we assume that people have two types of financial assets: money (earns no interest, bonds (earn interest) To be able to understand how individuals decide to divide their assets between money and bonds we need to make sure we understand what bonds are and how they are priced. Present value: the value now of one or more payments or receipts made in the future. Consider an asset that pays in one year"s time. If the interest rate is i% per year, the pv of the asset is: Notice that, ceteris paribus, the pv is negatively related to the interest rate. Suppose a pays 10% at the end of each of three years, at which point it is redeemed. Consider a competitive market of bonds: buyers should be prepared to pay no more than the bond"s pv, sellers should be prepared to accept no less than the bond"s pv.

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