4.1 Financial Assets

Financial assets — money, stocks, and bonds — differ in liquidity (how easily they convert to cash) and rate of return. Money is perfectly liquid but earns little or no interest; bonds and stocks pay more but are harder to spend. The interest you give up by holding money is the opportunity cost of holding it.

The tested relationship: bond prices and interest rates move inversely. A bond promises fixed payments, so when market interest rates rise, new bonds pay more and existing bonds with their lower fixed payments become less attractive — their price falls. When interest rates fall, existing bonds' prices rise.

On the exam, expect a quick logic check: 'the Fed's action raises interest rates — what happens to bond prices?' They fall. Anchor the inverse relationship rather than memorizing scenarios one by one.