FFM CH6 - Chapter6 InterestRates Levels Curves 61...

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Interest Rates Chapter 6 Cost of Money and Interest Rate  Levels Determinants of Interest Rates The Term Structure and Yield  Curves Using Yield Curve to Estimate Future  Interest Rates 6-1
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What four factors affect the level of  interest rates? Production  opportunities (cash  generation) Time preferences for  consumption vs.  savings Risk Expected inflation aka  increase in prices 6-2
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Supply & Demand for Funds 6-3 Supply: upward sloping b/c more $ made available as r increases Demand: downward sloping b/c more want to borrow as r decreases Risk Premium in low risk situation: 7%-5% = 2%, once the flight to quality  occurs, it’s 4%.
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6-4 Green = recessions Demand for funds  decline Fed makes more  money available to  stimulate, inflation  declines, interest  rates decline from  lack of demand
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Macroeconomic Factors That Influence  Interest Rate Levels 6-5 Federal reserve policy Federal budget deficits or surpluses International factors Level of business activity
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“Nominal” vs. “Real” Rates 6-6 r = represents any nominal rate r* = represents the “real” risk-free rate  of interest.  Like a T-bill rate, if there was  no inflation.  Typically ranges from 1% to  5% per year.
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Determinants of Interest Rates 6-7 r = r* + IP + DRP + LP + MRP r = required return on a debt security r* = real risk-free rate of interest IP = inflation premium (expectation in the future)
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