Present value discounts a future cash flow to today
Price equals present value of coupons plus face value
Rising rates lower bond prices (interest-rate risk)
Nominal rate is quoted, real rate is after inflation
Rates are set by bond supply and demand
Same maturity can still mean different yields
Yield curve plots yield versus maturity at equal risk
Three theories: expectations, segmented markets, liquidity premium
Liquidity effect lowers rates immediately
Ratings grade default risk from AAA down to D
March 2020 was a dash for cash in which even Treasuries sold off and their yields rose
Manages money supply and short-term rates
Money supply equals the multiplier times the monetary base
Reserves are deposits at the central bank plus vault cash
Primary tool: buying or selling government securities
Four tools: open market operations, discount rate, reserve requirements, interest on reserves
Goal hierarchy led by price stability
Policy rate reacts to the inflation gap and the output gap
Discretion tempts surprise inflation, the time-inconsistency problem
Policy works through expectations
A tool for the zero lower bound
Equation of exchange: $MV = PY$
Many channels, not just the interest rate
Policy rate is set where reserve supply meets reserve demand
At the zero lower bound conventional rate cuts lose traction
Demand-pull: excess demand lifts prices and output together
Disinflation lowers the inflation rate, deflation lowers the price level
Deflation is a sustained fall in the price level (negative inflation)
Volcker (Fed Chair from 6 August 1979) broke 1970s inflation by tightening hard, with the funds rate peaking near 20% by June 1981
US inflation rose from low single digits to roughly 14 to 15 percent by early 1980
Prices reflect all available information
Price is set by the best-informed traders at the margin
A share equals the present value of future dividends
Forecasts use all available information
Investors show overconfidence, loss aversion, and herding
Asset demand: wealth, expected return, risk, liquidity
Microstructure is how trades execute: orders, quotes, and the spread
A short squeeze is forced covering by crowded short sellers that amplifies a price rise
Digital value on a distributed ledger
Money is a medium of exchange, unit of account, and store of value
Pegged to fiat and backed by reserves
Digital central bank money, a direct central bank liability
Three functions: medium of exchange, unit of account, store of value
UST was an algorithmic stablecoin, not reserve-backed, paired with Luna through a mint-and-burn arbitrage
Assets are reserves, securities, and loans
Capital is the loss-absorbing cushion
Banks are liquid for depositors but hold illiquid loans
Asymmetric information drives the case for regulation
The safety net creates moral hazard
Securitization turns loans into tradable securities
More and higher-quality capital vs risk-weighted assets
Direct finance: borrowers sell securities to lenders in markets
Borrowers know more than lenders: asymmetric information
Manage liquidity, assets, liabilities, and capital together
A crisis is an explosion of asymmetric-information problems
Central bank supplies emergency liquidity in a panic
Sequence: mortgage credit boom and housing bubble (peak 2006), subprime bust through 2007, then global panic after Lehman on 15 September 2008
The exchange rate is the price of one currency in another
Long-run exchange rates move toward purchasing power parity
Short-run exchange rates clear the market for assets
Floating (market-set) vs fixed (defended peg), with managed floats between
The balance of payments records cross-border flows
A fixed rate, free capital flows, and monetary autonomy could not coexist, and weak banks deepened the break
SBV runs a managed float, namely a daily central reference rate (since 4 January 2016) plus a spot trading band (±5% from 17 October 2022)