Graph Instructions: - Click on any of the boldfaced number boxes to change the value of:
- Income ($0.00 – $10,000.00)
- the (Market) Interest Rate (0% – 50%)
- the Cost per Transaction ($0.00 – $500.00)
- the # of Transactions (1 – 100)
- Given the values in part 1), observe the resulting average (money) balance held, implied velocity, and related costs.
- Note the optimal # of transactions given the level of income, interest rate and cost per transaction
of part 1).
- Change the # of Transactions to a value closer to the optimal # and note change in part 3).
- Click "Reset" to start over.
Questions: Suppose your monthly paycheck is deposited directly into your checking account on the first day of each month. You spend your entire paycheck and your spending is spread evenly over the month. You can either leave your entire balance in your checking account, which pays no interest, or put some of your money into an interest-bearing bond fund. There is a transaction fee associated with each withdrawal from the bond fund. - If your monthly income is $3000, the monthly interest rate on the bond account is 1 percent and the cost per withdrawal from the bond account is $5, how many times should you shift funds from the bond account to your checking account? What is the implied velocity of this strategy?
- Holding everything else constant, increase the interest rate on the bond fund to 3 percent per month. What happens to the optimal number of transactions? What happens to the implied velocity?
- Leave the interest rate at 3 percent and reduce the cost per transaction to $2.50. What happens to the optimal number of transactions and to velocity? What might bring about a reduction in the cost per transaction?
- Keeping the interest rate at 3 percent and the cost per transaction at $2.50, increase your monthly income to $6000. What happens to the optimal number of transactions and to velocity?
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