4. Why Interest Rates Change. demand for assets and interest equilibrium

why interest rate change lecture

1. Why do interest rates change Demand for assets Interest rates equilibrium

2. Determinants of asset demand Demand for an asset is influenced by the following factors: 1. Wealth When our wealth increases, we have more resources available with which we can purchase assets, Thus, holding everything constant, an increase in wealth raises the quantity demand of an asset

3. Determinants of asset demand 2. Expected return =∑ RiPi When expected return on asset rises relative to expected returns on alternative assets, holding everything else constant, demand for that asset will also rise 3. Risk = Standard deviation of returns Investors are usually risk averse and want to reduce the uncertainty with the returns on an asset Hence, holding everything constant, if an asset’s risk rises relative to that of alternative assets, its quantity demanded will fall

4. Determinants of asset demand 4. Liquidity Liquidity means how quickly an asset can be converted into cash at low cost The more liquid an asset is to alternative assets, holding everything else unchanged, the more desirable it is, and the greater will be the quantity demand.

5. Supply and demand in the bond market Supply of and demand for bonds determine interest rates Remember the following relationships: Interest rates and bond prices have inverse relationships When interest rates rise, quantity demanded of bonds rises and quantity supplied falls