Financial Terms Quantity Theory of Money

# Definition of Quantity Theory of Money

## Quantity Theory of Money

theory that velocity is constant, and so a change in money supply will change nominal income by the same percentage. Formalized by the equation Mv = PQ.

# Related Terms:

## Agency theory

The analysis of principal-agent relationships, wherein one person, an agent, acts on behalf of
anther person, a principal.

## Arbitrage Pricing Theory (APT)

An alternative model to the capital asset pricing model developed by
Stephen Ross and based purely on arbitrage arguments.

## At-the-money

An option is at-the-money if the strike price of the option is equal to the market price of the
underlying security. For example, if xyz stock is trading at 54, then the xyz 54 option is at-the-money.

## Bubble theory

Security prices sometimes move wildly above their true values.

## Call money rate

Also called the broker loan rate , the interest rate that banks charge brokers to finance
margin loans to investors. The broker charges the investor the call money rate plus a service charge.

## Economic order quantity (EOQ)

The order quantity that minimizes total inventory costs.

## Hot money

money that moves across country borders in response to interest rate differences and that moves
away when the interest rate differential disappears.

## In-the-money

A put option that has a strike price higher than the underlying futures price, or a call option
with a strike price lower than the underlying futures price. For example, if the March COMEX silver futures
contract is trading at \$6 an ounce, a March call with a strike price of \$5.50 would be considered in-the-money
by \$0.50 an ounce.
Related: put.

## Liquidity theory of the term structure

A biased expectations theory that asserts that the implied forward
rates will not be a pure estimate of the market's expectations of future interest rates because they embody a

## Local expectations theory

A form of the pure expectations theory which suggests that the returns on bonds
of different maturities will be the same over a short-term investment horizon.

## Market segmentation theory or preferred habitat theory

A biased expectations theory that asserts that the
shape of the yield curve is determined by the supply of and demand for securities within each maturity sector.

## Modern portfolio theory

Principles underlying the analysis and evaluation of rational portfolio choices
based on risk-return trade-offs and efficient diversification.

## Money base

Composed of currency and coins outside the banking system plus liabilities to the deposit money banks.

## Money center banks

Banks that raise most of their funds from the domestic and international money markets, relying less on depositors for funds.

## Money management

Related: Investment management.

## Money manager

Related: Investment manager.

## Money market

money markets are for borrowing and lending money for three years or less. The securities in
a money market can be U.S.government bonds, treasury bills and commercial paper from banks and
companies.

## Money market demand account

An account that pays interest based on short-term interest rates.

## Money market fund

A mutual fund that invests only in short term securities, such as bankers' acceptances,
commercial paper, repurchase agreements and government bills. The net asset value per share is maintained at
\$1. 00. Such funds are not federally insured, although the portfolio may consist of guaranteed securities
and/or the fund may have private insurance protection.

## Money market hedge

The use of borrowing and lending transactions in foreign currencies to lock in the
home currency value of a foreign currency transaction.

## Money market notes

Publicly traded issues that may be collateralized by mortgages and MBSs.

## Money purchase plan

A defined benefit contribution plan in which the participant contributes some part and
the firm contributes at the same or a different rate. Also called and individual account plan.

## Money rate of return

Annual money return as a percentage of asset value.

## Money supply

M1-A: Currency plus demand deposits
M1-B: M1-A plus other checkable deposits.
M2: M1-B plus overnight repos, money market funds, savings, and small (less than \$100M) time deposits.
M3: M-2 plus large time deposits and term repos.
L: M-3 plus other liquid assets.

## New money

In a Treasury auction, the amount by which the par value of the securities offered exceeds that of
those maturing.

## Normal backwardation theory

Holds that the futures price will be bid down to a level below the expected
spot price.

## Out-of-the-money option

A call option is out-of-the-money if the strike price is greater than the market price
of the underlying security. A put option is out-of-the-money if the strike price is less than the market price of
the underlying security.

## Precautionary demand (for money)

The need to meet unexpected or extraordinary contingencies with a
buffer stock of cash.

## Preferred habitat theory

A biased expectations theory that believes the term structure reflects the
expectation of the future path of interest rates as well as risk premium. However, the theory rejects the
assertion that the risk premium must rise uniformly with maturity. Instead, to the extent that the demand for
and supply of funds does not match for a given maturity range, some participants will shift to maturities
showing the opposite imbalances. As long as such investors are compensated by an appropriate risk premium
whose magnitude will reflect the extent of aversion to either price or reinvestment risk.

## Pure expectations theory

A theory that asserts that the forward rates exclusively represent the expected
future rates. In other words, the entire term structure reflects the markets expectations of future short-term
rates. For example, an increasing sloping term structure implies increasing short-term interest rates. Related:
biased expectations theories

## Speculative demand (for money)

The need for cash to take advantage of investment opportunities that may arise.

## Static theory of capital structure

theory that the firm's capital structure is determined by a trade-off of the
value of tax shields against the costs of bankruptcy.

## Time value of money

The idea that a dollar today is worth more than a dollar in the future, because the dollar
received today can earn interest up until the time the future dollar is received.

## Transaction demand (for money)

The need to accommodate a firm's expected cash transactions.

## Money Market

A market that specializes in trading short-term, low-risk, very liquid
debt securities

## economic order quantity (EOQ)

an estimate of the number
of units per order that will be the least costly and provide
the optimal balance between the costs of ordering
and the costs of carrying inventory

## material quantity variance

(actual quantity X standard price) - (standard quantity allowed  standard price);
the standard cost saved (favorable) or expended (unfavorable)
due to the difference between the actual quantity
of material used and the standard quantity of material
allowed for the goods produced during the period

## standard quantity allowed

the quantity of input (in hours or some other cost driver measurement) required at standard for the output actually achieved for the period

## theory of constraints (TOC)

a method of analyzing the bottlenecks
(constraints) that keep a system from achieving
higher performance; it states that production cannot take
place at a rate faster than the slowest machine or person
in the process

## Materials quantity variance

The difference between the actual and budgeted quantities
of material used in the production process, multiplied by the standard cost per
unit.

## economic order quantity

Order size that minimizes total inventory costs.

## expectations theory of exchange rates

theory that expected spot exchange rate equals the forward rate.

## money market

Market for short-term financial assets.

## pecking order theory

Firms prefer to issue debt rather than equity if internal finance is insufficient.

## random walk theory

Security prices change randomly, with no predictable trends or patterns.

Debt levels are chosen to balance interest tax shields against the costs of financial distress.

See money base.

## Money

Any item that serves as a medium of exchange, a store of value, and a unit of account. See medium of exchange.

## Money Base

Cash plus deposits of the commercial banks with the central bank.

## Money Market

A financial market in which short-term (maturity of less than a year) debt instruments such as bonds are traded.

## Money Multiplier

Change in the money supply per change in the money base.

## Money Rate of Interest

See interest rate, nominal.

## Neutrality of Money

The doctrine that the money supply affects only the price level, with no long-run impact on real variables.

## Printing Money

Sale of bonds by the government to the central bank.

A firm that reacts to excess supply or excess demand by adjusting quantity rather than price. Contrast with price adjuster.

Belief that business cycles arise from real shocks to the economy, such as technology advances and natural resource discoveries, and have little to do with monetary policy.

## Real Money Supply

money supply expressed in base-year dollars, calculated by dividing the money supply by a price index.

## Fiat Money

Fiat money is paper currency made legal tender by law or fiat. It is not backed by gold or silver and is not necessarily redeemable in coin. This practice has had widespread use for about the last 70 years. If governments produce too much of it, there is a loss of confidence. Even so, governments print it routinely when they need it. The value of fiat money is dependent upon the performance of the economy of the country which issued it. Canada's currency falls into this category.

## Money Laundering

This is the process by which "dirty money" generated by criminal activities is converted through legitimate businesses into assets that cannot be easily traced back to their illegal origins.

## Money Market

Financial market in which funds are borrowed or lent for short periods. (The money market is distinguished from the capital market, which is the market for long term funds.)

## money market fund

A type of mutual fund that invests primarily in short-term debt securities maturing in one year or less. These include treasury bills, bankers’ acceptances, commercial paper, discount notes and guaranteed investment certficates.

## money order

A guaranteed form of payment in amounts up to and including \$5,000. You might request a money order in order to pay for tuition fees at a university or a college, or for a magazine subscription.