Overnight Rate
The interest rate on an interbank loan for one night.
Policy Interest Rate
The BoC’s target for the overnight rate.
Operating Band
The difference between the Bank Rate (ceiling) and the Deposit Rate (floor).
Corridor System
0.5% or 50 basis points.
Floor System
0.25%.
Modified Floor System
0.3%.
Money Demand
There must be a demand for loans from households and firms.
Regulatory Requirements
Banks must maintain certain liquidity and capital (equity) requirements (e.g., Base 1).
Tier 1
common equity/risk weighted assets is greater than or equal to 0.45
What is a Bond?
A fixed-income financial security used by governments and corporations to raise funds (borrow money).
Coupon Rate
The percentage of the face value paid regularly.
Coupon Payment
Coupon Rate* Face Value
Face Value (Principal)
The amount returned to the bondholder at maturity.
Yield to Maturity (YTM)
The total return anticipated on a bond if held until it matures (changes with market conditions).
Price and Yield Relationship
There is a negative inverse relationship between the price of a bond and its YTM.
If Price > Face Value, then
YTM < Coupon Rate.
Pricing Formula Example
For a bond with a $$1000$ face value and $$50$ coupon: $$\text{Price} = \frac{\text{Coupon} + \text{Face Value}}{1 + \text{YTM}}$$ If Price is $$1020$: $1020 = \frac{50 + 1000}{1 + 0.03}$ (YTM is $3\%$).
define quantitative easing
QE involves large-scale purchases of government bonds by the Central Bank in the secondary market.
Main Goals of QE
Provide Abundant Liquidity: Ensure the banking system has enough settlement balances.
Decrease Long-Term Rates
By buying medium and long-term bonds, the BoC pushes bond prices up and yields down.
The Balance Sheet Process (Direct Purchase Example)
If the BoC directly buys new government bonds to finance a deficit:
Institution
Assets Liabilities Bank of Canada + Securities (Bonds) + Govt. Deposits Banking System + Settlement Balances + Chequable Deposits
The End Result:
Government Bonds $\uparrow$ Settlement Balances $\uparrow$ Monetary Base (MB) $\uparrow$ Chequable Deposits ($D$) $\uparrow \implies$ Money Supply ($M$) $\uparrow$
Perfect Competition
Large number of firms; each firm is small relative to the market (price takers).
