THE BEHAVIOR OF INTEREST RATE CHAPTER 4 NOORAINA BINTI PAHARUDDIN

BEHAVIOUR OF INTEREST RATES

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THE BEHAVIOR OF INTEREST RATE CHAPTER 4 NOORAINA BINTI PAHARUDDIN by Mind Map: THE BEHAVIOR OF INTEREST RATE CHAPTER 4 NOORAINA BINTI PAHARUDDIN

1. Measuring interest rates: Yield to maturity(YTM)

1.1. Most accurate measure of IR

1.2. Also called internal rate return (IRR)

1.3. Formula P = C/(1+i)^n

1.4. 1)Bond = FV, YTM interest = coupon rate 2)Price of bond is YTM are negative related 3)YTM>coupon rate when bond price is < FV

1.5. Bond identification: 1) corporation or government issued 2)Maturity date 3)Coupon rate

2. Concepts of Interest Rates and Rate of Return

2.1. Interest Rates

2.1.1. Return on capital

2.1.2. Borrower = payment for obtaining credit(loan)

2.1.3. Lender = amount of funds (money) they receive when extend credit

2.2. Rates of Return

2.2.1. Bond =Return on investment

2.2.2. Security = payments to the owner + change in value

2.2.3. Return on a bond not necessary equal to IR (YTM) on that bond

2.2.4. Returns is vary according to investment vehicle

3. Concepts of Nominal and Real Interest Rates

3.1. Nominal Interest Rates

3.1.1. Rate of interest that accrued at some time in future

3.1.2. Exchange rate of RM now and RM in future

3.1.3. Eg; NIR = 10%per annum. Borrowed RM10 this year, sum payable is RM11 next year

3.1.4. Ignores the effect of Inflation.

3.2. Real Interest Rate

3.2.1. Rate of interest in future after discounting rate of inflation.

3.2.2. True cost of borrowing

3.2.3. Irving Fisher: 1) Real = Nominal - Expected Inflation 2) Nominal = Real + Expected Inflation

3.2.4. RIR is low, greater incentives to borrow and fewer incentives to lend, vice versa

3.3. Determination of the Market Interest Rates - Theory of Asset Demand

3.3.1. Determinants of Asset Demand

3.3.1.1. Wealth

3.3.1.2. Expected Return

3.3.1.3. Risk

3.3.1.4. Liquidity

3.3.2. Theory of Asset Demand

3.3.2.1. Quantity demanded of asset is positively related to wealth

3.3.2.2. Qty demanded of asset is positively related to expected return

3.3.2.3. Qty demanded of asset is negatively related to risk of its return

3.3.2.4. Qty demanded of asset is positively related to its liquidity

3.3.3. Interest Rate Determination in an Economic System: An Introduction

3.3.3.1. Demand and Supply in the Credit market

4. Determination of interest rates

4.1. Loan-able funds theory (LF)

4.2. Liquidity Preference Theory (LP)

4.3. THE CLASSICAL MODEL

4.3.1. Loan-able Fund Theory - Fisherian Real Interest Rate Theory (Demand and Supply in the Savings & Investment Market

4.3.1.1. Supplier of Loan-able Funds

4.3.1.2. Demand for Loan-able Funds

4.3.1.3. The Crowding Out Effect (Government deficit spending)

4.3.2. Loanable Funds Theory Framework/Framework Revisited

4.3.2.1. Demander/ buyer bond = Supplier loan-able fund

4.3.2.2. supplier/ seller bond = demander loadable fund

4.3.3. Market Equilibrium in the Loan-able Funds Framework

4.3.4. Changes in Equilibrium Interest Rate in the Loan-able Funds Framework

4.3.4.1. Factors that influence the demand curve for bond/supply curve for loan-able fund to shift:

4.3.4.1.1. 1) Wealth

4.3.4.1.2. 2) Expected Returns

4.3.4.1.3. 3) Risk of bonds

4.3.4.1.4. 4) Information cost of bond

4.3.4.1.5. 5) Liquidity

4.3.4.2. Factors that influence the supply for bond to shift:

4.3.4.2.1. 1) Expected profitability of investment opportunities

4.3.4.2.2. 2) Expected inflation

4.3.4.2.3. 3) Government activities/borrowing

4.3.4.2.4. 4) Business taxation

4.3.5. Shifts in Both Demand and Supply of Bonds

4.3.5.1. Factors that influence the supply/demand curve for bond to shift:

4.3.5.1.1. 1) Changes in Expected Inflation: The Fisher Effect

4.3.5.1.2. 2) Business Cycle Expansion/Contraction

4.3.6. The Liquidity Preference Framework (Supply and Demand in the Money Market)

4.3.6.1. Transactionary Motives

4.3.6.2. Precautionary Motive

4.3.6.3. Speculative Motive

4.3.7. Determination of interest rate in the liquidity preference theory

4.3.8. Changes in Equilibrium Interest Rates

4.3.8.1. Shifts in the Demand for Money

4.3.8.1.1. Income Effect/Business Cycle Fluctuations

4.3.8.1.2. Price Level Effect/Inflation

4.3.8.2. Shifts in the supply of money

4.3.9. Changes in the Equilibrium Interest Rate Due to:

4.3.9.1. Changes in Income

4.3.9.2. Change in the Price Level

4.3.9.3. Change in Money Supply

4.3.10. Further Analysis of the Determination of Interest Rate in the Liquidity Preference Theory (Money Demand and Money Supply Analysis) using REAL BALANCE

4.3.10.1. Real Money Supply = Money Supply/Price

4.3.10.2. Increase in PRICE LEVEL

4.3.10.3. Increase in PRICE LEVEL