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The Bond and Foreign Exchange Markets

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Lesson 10-1 The Bond and Foreign Exchange Markets Financial markets are markets where funds accumulated by one group are made available to another group. – PowerPoint PPT presentation

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Title: The Bond and Foreign Exchange Markets


1
Lesson 10-1 The Bond and
Foreign Exchange Markets
2
Financial markets are markets where funds
accumulated by one group are made available to
another group.   The Bond Market   Bond Prices
and Interest Rates   The face value of a bond is
the value printed on the bond.   The maturity
date is the date on which the face value will be
paid by the issuer of the bond.  
3
An interest rate is the payment made for the use
of money expressed as a percentage of the amount
borrowed.   As the bond price falls, the interest
rate rises. As the bond price rises, the interest
rate falls.   The coupon rate is the percentage
of the face value that will be paid periodically
to the holder of the bond.
4
If a bond does not carry a coupon rate and thus
pays only the face value when it matures, it is
called a zero-coupon bond.   Bond prices are
determined by supply and demand and can be
illustrated graphically.   Supply and demand
curves for bonds have normal slopes.
5
The Bond Market and Macroeconomic
Performance   The price of bonds determines the
interest rate.   Changes in the interest rate
affect investmenthigher rates discourage the
purchase of more plant and equipment, whereas
lower rates encourage such purchases.   Since
investment is a component of aggregate demand, a
change in the interest rate shifts aggregate
demand.   .
6
The links between bond prices and the interest
rate, the interest rate and investment, and
investment and aggregate demand can be
illustrated graphically Higher interest rates
tend to reduce aggregate demand and lower
interest rates tend to increase aggregate demand,
if other factors are unchanged.
7
Foreign Exchange Markets   The foreign exchange
market is a market in which currencies of
different countries are traded for one another.A
countrys exchange rate is the price of its
currency in terms of another currency or
currencies.   Economists summarize the movement
of exchange rates with a trade-weighted exchange
rate. The trade-weighted exchange rate is an
index of exchange rates in which the exchange
rate between a country and each of its trading
partners is weighted by the amount of trade
between the two countries.   The trade-weighted
exchange rate will be used when reference is made
to the exchange rate.
8
Determining Exchange Rates   Exchange rates
usually are determined by supply and
demand.   The demand curve for a currency relates
the number of domestic currency units buyers want
to buy in any period to the exchange rate.   An
increase in the exchange rate means that it takes
more foreign currency to buy the domestic
currency. A decrease in the exchange rate means
that it takes less foreign currency to buy the
domestic currency.   A rise in the exchange rate
makes foreign goods relatively cheaper. A fall in
the exchange rate makes foreign goods relatively
more expensive.
9
As the exchange rate rises, domestic goods appear
more expensive to foreigners. As the exchange
rate falls, domestic goods appear less expensive
to foreigners.   The demand curve for any
currency is expected to be downward
sloping.   The supply of foreign exchange relates
the quantity of foreign currency units to the
exchange rate that domestic residents want to buy
in a period.   The supply curve for foreign
exchange is usually upward sloping.   Governments
also sometimes intervene in the foreign exchange
markets, but the volume is relatively
small.      
10
Exchange Rates and Macroeconomic
Performance   People purchase a countrys
currency either to buy its goods or to buy its
assetsmoney, capital, stocks, bonds, or real
estate.   If bond prices in a country fall, the
relative interest rate in that country rises and
stimulates foreign investors to buy the countrys
currency in order to buy bonds. The exchange rate
thus rises.   A higher exchange rate makes the
price of domestic goods more expensive to
foreigners and thus reduces exports while at the
same time reduces the price of foreign goods to
domestic buyers and therefore stimulates more
imports. Net exports fall.
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