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CHAPTER 2: DETERMINANTS OF INTEREST RATES - Coggle Diagram
CHAPTER 2: DETERMINANTS OF INTEREST RATES
2.1 Overview
Def:
The price of borrowing/ lending
Income
for one side,
cost
for another side
Nominal interest rate:
the interest rates actually observed in financial market
Purpose: determine fair value and prices of securities
2 components:
Opportunity cost
and
Adjustments for individual security characteristics
Fisher equation: Real IR = Nominal IR - Inflation (interest rate contain a premium for expected inflation)
2.2 Loanable Fund Theory
Overview of LF
:
Used to explain IR and IR movements
Def: a theory of IR determination (1) that views equilibrium IR in FM (2) as a result of the Supply and Demand for loanable funds (3)
Supply of loanable funds
IR and quantity supply of loanable funds have
positive relationship
(IR tăng thì lượng cung LF tăng)
Factors cause Supply curve to shift:
Wealth:
Risk:
Near-term spending needs
Monetary expansion
Suppliers
Households
(consumer)
Largest supplier
of loanable funds:
High economic growth => replace cash holdings with earning asset => increase total supply of LF
Determinants: IR, wealth, risk of security investment, immediate spending needs
Determinants of household savings:
Interest rates (+) and Tax policy (-)
Income and wealth (+)
Attitudes about saving vs borrowing
Credit availability (-)
Job security and belief in soundness of entitlements (-)
Governments
:
Sometimes generate more cash inflows (tax)
Loan out to FM fund users (i.e: in financial crisis)
Các thành phần của một nền KT:
Households
Businesses
Foreign
Local State Gov
Federal Gov
Demand of loanable funds
Households
:
Borrow for purchases of homes, durable good (car,..) & non durable goods (education, medical,..)
Ngân sách cân bằng
: thu đủ sponsor cho chi (1) và tích lũy (2)
Đi vay trở thành 1 việc bình thường và
KHÔNG
violate Ngân sách cân bằng <=>
Đầu tư cho các khoản chi có giá trị lớn (mua nhà, ô tô,..)
IR increase -> Demand decrease
Businesses
:
Borrow for
long-term
(plant, equipment,..) and
short-term
(inventory,..) investments
IR increase => finance investment with generate funds (i.e: retained earnings) rather than borrowed funds
The
more
profitable/ good economic condition => the
higher
demand for LF
Governments
Role
:
Quản lý
Điều tiết
Phân bổ
=> Thu (taxation) và Chi (spending)
Budget deficit (Thâm hụt ngân sách)
:
Tăng thu, giảm chi (tight fiscal policy)
In tiền
Đi vay (i.e: issue T-bills) => lợi ích: tổng chi phí lãi < tổng chi phí giải quyết thâm hụt ngân sách
Perfectly inelastic demand
Đường cầu (DA) thẳng đứng => vertical straight line
Với mọi IR, CP vẫn sẽ đi vay cho tới khi bù đắp hết thâm hụt ngân sách
"Crowding out"
Budget deficit =>
Gov increase borrowing
=> Demand for LF increase => IR increase =>
Compete with private borrowers (firms and indi) and discourage them to borrow
=> Decrease investment in businesses => Hinder economic growth
Factors that cause Demand curve to shift:
Utility derived from assets purchased with borrowed funds
Restrictiveness of nonprice conditions on borrowed funds
Economic conditions
Determinants of interest rates (nói chung)
:
Economic growth
Inflation
Money supply
Government expenditure
2.3 Determinants of interest
rates for individual securities
Inflation:
Higher inflation => Higher IR
Def: the (percentage) increase in the price of a standardized basket of goods and services over a given period of time
Real Interest Rates
Default or Credit risk
Higher default risk => Higher IR
Not all securities exhibit default risk (i.e:T-bills)
DRP (Default Risk Premium): tend to increase when economy go down, and decrease when economy expand
Liquidity risk
High liquidity: sold at a predictable price (1) with low transaction costs (2) thus can be converted into its full market value at short notice
Investors demand
liquidity premium on top of all other premium
for bond's lack of liquidity
Special provisions or Covenants
Provide benefits to security holders (tax-free status and convertibility) => lower IR
Provide benefits to security issuers (call provision) => higher IR
Term to maturity
2.4 Term structure of interest rates
Unbiased expectation theory
Liquidity premium theory
Market segmentation theory
2.5 Time value of money and Interest rates
Time value of money
: a dollar receive today is worth more than a dollar received at some future date
Simple interest: interest earned on an investment is
NOT
reinvested
Compound interest: reinvested
Lump sum
Lump sum payment
: single cash payment receive at the beginning or end of some investment horizon (i.e: $100 at the end of five years)
Lump sum valuation
PV of a lump sum
FV of a lump sum
Annuity valuation
PV of an annuity
FV of an annuity