chapter 2note - Omar M. Al Nasser, Ph.D., MBA. Visiting...

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Omar M. Al Nasser, Ph.D., MBA. Visiting Assistant Professor of Finance School of Business Administration University of Houston-Victoria Email: alnassero@uhv.edu Chapter 2 Determination of Interest Rates Outline Loanable Funds Theory Household Demand for Loanable Funds Business Demand for Loanable Funds Government Demand for Loanable Funds Foreign Demand for Loanable Funds Aggregate Demand for Loanable Funds Supply of Loanable Funds Equilibrium Interest Rate Economic Forces That Affect Interest Rates Impact of Economic Growth on Interest Rates Impact of Inflation on Interest Rates Impact of Monetary Policy on Interest Rates Impact of the Budget Deficit on Interest Rates Impact of Foreign Flows of Funds on Interest Rates Summary of Forces That Affect Interest Rates Forecasting Interest Rates Key Concepts 1. Explain the Loanable Funds Theory by deriving demand and supply schedules for loanable funds. 2. Explain the Fisher Effect, and tie it in with Loanable Funds Theory by explaining how inflation affects the demand and supply schedules for loanable funds. 3. Provide additional applications (especially current events) one at a time to help illustrate how events can affect the demand and supply schedules, and therefore influence interest rates.
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4. Explain how forecasts of interest rates are needed to make financial decisions, which require forecasts of shifts in the demand and supply schedules for loanable funds. 5. Introduce several possible events simultaneously to illustrate how difficult it can be to forecast interest rate movements when several events are occurring at once. POINT/COUNTER-POINT: Does a Large Fiscal Budget Deficit Result in Higher Interest Rates? POINT: No. In some years (such as 2003), the fiscal budget deficit was large and interest rates were very low. COUNTER-POINT: Yes. When the federal government borrows large amounts of funds, it can crowd out other potential borrowers, and the interest rates are bid up by the deficit units. WHO IS CORRECT? Use the Internet to learn more about this issue. Offer your own opinion on this issue. ANSWER: A large budget deficit does not automatically cause high interest rates. However, it does result in a large demand for funds, which will place upward pressure on interest rates unless there are offsetting forces. Questions 1. Interest Rate Movements. Explain why interest rates changed as they did over the past year. ANSWER: This exercise should force students to consider how the factors that influence interest rates have changed over the last year, and assess how these changes could have affected interest rates. 2. Interest Elasticity. Explain what is meant by interest elasticity. Would you expect federal government demand for loanable funds to be more or less interest-elastic than household demand for loanable funds? Why? ANSWER: Interest elasticity of supply represents a change in the quantity of loanable funds supplied
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This note was uploaded on 09/21/2011 for the course FINANCE 3321 taught by Professor Jianjundu during the Fall '11 term at University of Houston-Victoria.

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chapter 2note - Omar M. Al Nasser, Ph.D., MBA. Visiting...

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