im6 - Chapter 6 Determining Market Interest Rates Overview...

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Chapter 6 Determining Market Interest Rates Overview The discussion of the determination of market interest rates adopts the bond market/loanable funds approach. Most students should find this makes the discussion of the determination of market interest rates straight-forward and intuitive. By simultaneously presenting both the bond market and the loanable funds perspective, the text helps to reinforce the sometimes elusive point that the prices of bonds and their yields move in opposite directions. Students can be directed to Tables 6.1 and 6.2, which present useful summaries of the factors that shift the demand and supply curves for bonds. The basic model is applied to a variety of questions including the reasons for falling interest rates during recessions and the impact of expected inflation on bond prices. The chapter concludes with a very good discussion of interest rate determination in the context of an international capital market. This material provides students with a much more realistic depiction of the workings of an open economy than can be found in competing texts, and does so in a nontechnical way. Outline I. Supply and Demand in the Bond Market and Loanable Funds A) The interest rate that prevails in the bond market is determined by the demand for and supply of bonds. B) If we view bonds as the good, then the lender is buying the bond, the borrower is selling the bond, and the amount the lender pays for the bond is the price of the bond. C) If we view the use of the funds as the good, then the borrower is the buyer, the seller is the supplier of funds, and the price of the funds is the interest rate. D) The demand curve for bonds (with the price of bonds on the vertical axis and the quantity of bonds on the horizontal axis) slopes down because the lender desires to purchase more bonds when the price of bonds is low. 1. The supply of loanable funds is equivalent to the demand for bonds. 2. The supply curve for loanable funds (with the interest rate on the vertical axis and the quantity of loanable funds on the horizontal axis) slopes up because lenders desire to loan more funds at higher interest rates.
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27 Hubbard • Money, the Financial System, and the Economy, Sixth Edition E) The supply curve for bonds slopes up because borrowers are willing to supply more bonds at higher prices. 1. The demand for loanable funds is equivalent to the supply of bonds. 2. The demand curve for loanable funds slopes down because borrowers desire to borrow more funds at lower interest rates. F) The intersection of the demand curve for bonds and the supply curve of bonds determines the equilibrium price of bonds; the corresponding interest rate is determined by the intersection of the demand curve for loanable funds and the supply curve of loanable funds. II.
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im6 - Chapter 6 Determining Market Interest Rates Overview...

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