CH6 - CHAPTER 6 Interest Rates F IN 3 4 0 3 B u s in e s s...

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CHAPTER 6 Interest Rates
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R i s k a n d R e t u r n B o n d s ( D e b t ) F I N 3 4 0 3 - B u s i n e s s F i n a n c e T e r m S t r u c t u r e S u p p l y / D e m a n d I n t e r e s t R a t e s B u s i n e s s C y c l e M o n e t a r y P o l i c y F i s c a l P o l i c y M i c r o D e t e r m i n a n t s Y i e l d C u r v e s P u r e E x p e c t a t i o n s L i q u i d i t y P r e f e r e n c e F i n a n c i a l D e c i s i o n s
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Price or Cost of Debt Capital What do we call the price, or cost, of debt capital? The interest rate or the cost of money.
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Price or Cost of Equity Capital What do we call the price, or cost, of equity capital? A “required return”, where, for stocks: Required Dividend Capital Return Yield Gain = +
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Cost of Money Factors affecting interest rates Macro: Production opportunities Time preference for consumption Micro: Risk Expected inflation
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D 1 D 2 S 1 S 2 r r * $ Interest Rates: Macro
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Supply and Demand Business cycle Monetary/fiscal policy Open market Fed-funds rate Reserve requirements Budget surplus or deficit
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Deposit Reserve Loanable 100.00 90.00 81.00 72.90 10.00 9.00 8.10 7.29 100.00 90.00 81.00 72.90 65.61 1,000.00 Reserve Requirements
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R i s k a n d R e t u r n B o n d s ( D e b t ) F I N 3 4 0 3 - B u s i n e s s F i n a n c e T e r m S t r u c t u r e S u p p l y / D e m a n d I n t e r e s t R a t e s B u s i n e s s C y c l e M o n e t a r y P o l i c y F i s c a l P o l i c y M i c r o D e t e r m i n a n t s Y i e l d C u r v e s P u r e E x p e c t a t i o n s L i q u i d i t y P r e f e r e n c e F i n a n c i a l D e c i s i o n s
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Interest Rates: Micro r * = Real, risk-free rate T-bond rate if no inflation historically between 1% to 4% r = Any nominal rate (includes an adjustment for inflation) r RF = Rate on Treasury securities
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r * r * + IP + DRP + LP + MRP Nominal rate on debt Real, risk-free rate Inflation premium Default risk premium Liquidity premium Maturity risk premium MRP LP DRP IP r r Interest Rates: Micro
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Nominal, Risk-Free Rate Arithmetic : r RF,1 = r * 1 + I 1 r RF,N = r * N + IP N r * N = [r * 1 + r * 2 + … + r * N ] / [N] IP N = [I 1 + I 2 + … + I N ] / [N] r = r + DRP + LP + MRP
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Nominal, Risk-Free Rate Geometric : r RF,1 = [(1+r * 1 )(1+I 1 )] - 1.0 r RF,N = [(1+r * N )(1+ IP N )] - 1.0 r * N = [(1+r * 1 )(1+r
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