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Money, Banking, and Financial Markets - Assignment Example

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Money, Banking, and Financial Markets

Since demand for money varies with interest rates, velocity also changes with changes in interest rates. Demand for money also depends upon the expectations about future interest rates. In an article published in The Globe and Mail on July 31, 2013, the author, Linda Stern, suggested to ignore advice such as “Don’t take a mortgage with you in retirement”, and “Older Folks should invest more conservatively” (Stern). In support to the view “Don’t take a mortgage with you in retirement”, it is stated in the article that carrying forward mortgages over a long period of time not only increases the risk of investment but also involves a greater expenditure on the side of the loan taker. Carrying a mortgage over a long period increases its value and interest, so it is advisable not to use a large amount when paying mortgages and instead to invest that extra amount in some other investment plans which may be beneficial in the long run. Earlier payment of mortgages is related to the emotions of the loan-taker, reduces the risk and leads to savings due to lower interest payments. Ignoring the advice may be risky, but it may bring greater potential and stronger chance of capitalization since no one is aware of the opportunities that may come in the future. The situation will be more understandable from the following example. A person has $100,000 in cash and a 15-year mortgage with a balance of $100,000 at 4% interest. Case 1: The person decides to pay off his mortgage with the available cash and to invest the mortgage payment that would have to be paid per month (i.e. $739) for 15years at 7%. By paying the mortgage, the person saves %33,143, and at the end of 15 years investment amounts to $237,706. Case 2: The person decides not to pay the mortgage and invest cash of $100,000 for 15 years at 7% interest. After 15 years, the investment amounts to $284,894, and $33,143 are paid as interest for the mortgage. Subtracting the payment, a net gain of $251,751 is made by the person, if he/she decides to pay off the mortgage later. On deciding to pay off the mortgage, the person has received an emotional satisfaction, less risk and higher liquidity, but he/she has also suffered an opportunity loss of $14,045. Thus, every financial investment and debt is added to a price and risk, but decision is to be taken wisely. In support to the view “Older Folks should invest more conservatively”, it is stated in the article that when a person moves towards old age, he/she should either invest less in stocks or withdraw all money from stocks and invest in instruments which will guarantee returns with less amount of risk involved. They may choose to invest in certificate of deposits or bonds. Investment on guaranteed returns for short term may hold a support to the person at the time of retirement since it would assure a return at the end of the period. But ignoring the advice, it can be said that investment in bonds too can be a risky investment to the investor since future can only be assumed and not ascertained. If the interest rate rises in future, the bond holders may lose value, and investment will become riskier. Even with the rise in the expected rate of inflation the investor may face the same risk. Thus, the person may face the same ...Show more

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Name Instructor Course Date Money, Banking, and Financial Markets Answer 1 In the Keynesian theory of money demand, Keynes stated that demand for money depends on interest and income. Money is held by an individual to facilitate normal transactions and to serve as a precaution for unexpected contingencies that may take place in the future…
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