Lec6 - Lecture 6 page 35 INTEREST RATES IN THE ECONOMY...

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Lecture 6 page 35 I NTEREST RATES IN THE ECONOMY Questions that we hope to answer from this chapter: 1. What are determinants of market interest rates? 2. How does the length to maturity affect interest rates on securities of equivalent risk? The Cost (%) of Money Money (funds) can be raised either through the issuance of debt or equity. In this section, we will discuss interest rates. When discussing interest rates, we are implicitly referring to debt as only debt pays interest to its holders. The Financial System and the Structure of Interest Rates business sector – Net demanders of capital household sector – net supplier of capital (net saver) What do households do with their savings and where can businesses go to borrow? Financial system Channel through which savings of surplus sector flows to deficit sector. Q: What determines the amount businesses want to borrow and households wish to save/lend, i.e., the supply and demand for capital? Cost of money. - Richard T. Bliss, Babson University and Terry D. Nixon, Miami University
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Lecture 6 page 36 Interest Rate (r) % 2 different markets Low-Risk High-Risk r r Dollars Dollars Supply and Demand for funds (investment capital) in capital markets (high-risk, low-risk, etc.) interact to determine interest rates. Once again, the above diagrams illustrate the relationship of risk relative to expected return in capital markets. All else constant, how would a business recession impact interest rates in our economy? Business recession – demand by businesses for each Rates would drop All else constant, how would a “loosening” of credit by the Federal Reserve impact interest rates in the economy? Are credit markets such as the high-risk and low-risk markets independent of each other? As risk premiaum (rH – rL) increases, more people willing to take risk. Supply moves from low to high. No. - Richard T. Bliss, Babson University and Terry D. Nixon, Miami University S D
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Lecture 6 page 37 Short-term and Long-term interest rates (see Figure 6-2 on page 187) Historically, are long-term rates generally higher or lower than short-term rates? (We’ll
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This note was uploaded on 10/19/2011 for the course FINANCE 301 taught by Professor Nixon during the Fall '11 term at Miami University.

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Lec6 - Lecture 6 page 35 INTEREST RATES IN THE ECONOMY...

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