4.1 — Financial Assets

Financial assets are places to store wealth, for example:

• Stocks
  • Equity ownership of a corporation
• Bonds
  • A loan to a corporation or government which is paid back with interest The problem with these financial assets is their lack of liquidity, which refers to the ability to purchase goods and services with one’s assets. In contrast, money is a liquid financial asset which can immediately be used to purchase goods and services.

Bond Prices vs Interest Rate

There is an inverse relationship between interest rates and bond prices.

• If interest rates fall, bond prices will increase
• Consequently, if interest rates go up, bond prices will go down

For example:

• if a bond price is $1000in1893witha5$1000
• if interest rates rise to 10% in 1920, the bond price will now be $500toensurethesame$50 payout
• Similarly, if interest rates fall to 2.5% in 1950, the bond price will be $2000toensurethesame$50 payout

Changes in interest rates can come from both the money market and the loanable funds market. Bonds earn interest while money doesn’t. This is the opportunity cost of liquid assets. As a result, the opportunity cost of holding money is the market interest rate.