Financial Markets and Institutions Test 2 Review

Financial Markets and Institutions Test 2 Review -...

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Financial Markets and Institutions Test 2 Review The equilibrium rate of interest is called the real rate of interest. Determined by the real output of the economy. The real rate of interest is estimated to be, on average about 3% for the US economy, and it varies between 2 and 4% because of changes in economic conditions. The higher the interest rate, the smaller the quantity of loanable funds demanded by DSU’s. Higher borrowing rates cause state and local governments to postpone capital expenditures, and reduce consumer installment purchases. If Prices rise during the life of a loan contract, the purchase power of the money decreases and borrowers repay lenders in inflated dollars or dollars with less purchasing power. If Price decrease, the purchasing power of the loaned money increases, and lenders receive a gain of more purchasing power at the expense of the borrowers. The Fisher equation is nominal rate of interest= real rate of interest + expected inflation x(real rate * expected inflation). The nominal rate of interest is defined as the rate of interest actually observed in financial markets (the market rate of interest). Changes in money supply, government spending, economic activity, and inflation determine interest rates. Chapter 5 Bond prices move inversely to interest rates. Time value of Money is based on the belief that people have a positive time preference for consumption; that is, people prefer to consume goods today rather than similar goods in the future. TVM simplified is “a dollar today is worth more than a dollar received at some future date. Future Value (FV) o FV is the value of a given amount of money invested today (Present Value) at some point in the future at a given interest rate. o Formula for finding Future Value (compounding) FV= PV (1 + i)ⁿ FV= future value of investment n periods in the future PV= present value (value today)

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I= interest rate N= number of interest rate compounding periods. o Quarterly= n*4, i/4 Present Value (PV) o Value of a given sum of money to be received at some point in the future, today. o Finding the present value of some future sum of money (called discounting) is the reverse of compounding. o PV= FV[1/(1+i)ⁿ] o The term in brackets is referred to as the discount factor (DF) and is equal to the reciprocal of the interest factor or (1/IF). Bond- contractual obligation of a borrower to make periodic cash payments to a lender over a given period of time. A bond constitutes a debt and therefore there is a borrower and a lender. o Borrower= Issuer o Lender= Investor or Bondholder o Consists of two types of contractual cash flows On maturity the lender is paid the original sum borrowed (principle, face value, or par value) The borrower or issuer must also make periodic interest payments to the bondholders called coupon payments. The magnitude of the coupon payments is determined by the coupon rate
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Financial Markets and Institutions Test 2 Review -...

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