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Money, Banking and Financial Markets > What determines interest rate? > Flashcards

What determines interest rate? Flashcards

1
Q

what is Loanable funds theory ?

A
  • real interest rates are determined by the supply and demand for loans
  • The theory assumes only one type of loan and one interest rate; it ignores the diversity of rates illustrated
  • The theory also assumes that savers lend directly to investors, which ignores the role of bank
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2
Q

what is Capital inflows?

A
  • funds provided to a country’s investors by foreigners
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3
Q

what is Capital outflows ?

A
  • Funds provided to foreign investors by a country’s savers
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4
Q

Net capital inflows :

A

capital inflows minus capital outflows

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5
Q

Private saving :

A
  • saving by individuals and firms
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6
Q

Public saving :

A
  • saving by the government (tax revenue minus government spending)
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7
Q

Budget surplus :

A
  • a positive level of public saving
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8
Q

Budget deficit :

A
  • a negative level of public saving
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9
Q

what affects have a higher real interest rate in the demand for loans ?

A
  • A higher real interest rate makes investment more costly, so fewer projects are undertaken. Lower investment means that investors want fewer loans.
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10
Q

Effects on the supply of loans, if the interest rate increase:

A
  • higher returns to saver
  • higher interest rate encourages people to save more
  • decreases capital outflows.
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11
Q

the equilibrium real interest rate, r*:

A
  • it is the interest rate at which the supply and demand curves intersect.
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12
Q

what happens when there is an excess of supply of loans?

A
  • it means that the interest rate is higher than the equilibrium
  • Not all lenders can find borrowers
  • In this situation, lenders should offer lower interest rates to attract borrowers, pushing rates down
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13
Q

what happens when there is an excess of demand for loans?

A
  • it means that the interest rate is lower than the equilibrium
  • not all borrowers can find lenders
  • borrowers offer higher rates to attract lenders, pushing rates up
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14
Q

Meaning of Budget surplus:

A
  • a positive level of public saving
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15
Q

Meaning of Budget deficit:

A
  • a negative level of public saving
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16
Q

what is Capital Flight ?

A
  • sudden decrease in net capital inflows that occurs when foreign savers lose confidence in an economy
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17
Q

Two categories of saving :

A
  • Private Saving
  • Public Saving
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18
Q

Why might capital flows shift?

A
  • Changes in Confidence
  • Foreign Interest Rates
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19
Q

How Foreign Interest Rates affected local interest rate ?

A
  • interest rates in different countries are connected
  • they tend to move in the same direction An event that raises the interest rate in one country, such as a higher budget deficit, reduces net capital inflows to other countries. The supply of loans falls in the other countries, so their interest rates rise too.
20
Q

Fisher equation : (formula)

A
  • the nominal interest rate equals the real rate plus expected inflation:

I=􏰀 r +􏰁 pie

  • “r” is the real interest rate
  • “i” is the nominal rate
  • “pie” is expected inflation
21
Q

Theory of Adaptive expectations: definition and formula

A
  • theory that people’s expectations of a variable are based on past levels of the variable; also, backward looking expectations.

pie =􏰀 pi-1

  • “pie“ mean expected inflation
  • “pi-1“ mean inflation of the last year
22
Q

Liquidity preference theory:

A
  • the nominal interest rate is determined by the supply and demand for money
23
Q

the key simplifying assumption that only two kinds of assets exist: (liquidity preference theory)

A
  • Money

the medium of exchange

People use money to purchase goods and services

they can’t use bonds.

  • Bonds

It pay interest but money does not

24
Q

what is money supply ?

A

The money supply is the total amount of money in the economy.

25
Q

what is money demand ?

A

Money demand is the amount of wealth that people choose to hold in the form of money.

26
Q

The equilibrium interest rate :

-Money demand and Money supply

A
27
Q

Liquidity Preference Theory: Factors That Can Change the Nominal Interest Rate

A
  • -Shifts in Money Supply
  • Decisions by the central bank
  • -Shifts in Money Demand
  • Changes in aggregate spending
  • Changes in transaction technologies
28
Q

Nominal GDP formula: (total spending)

A
  • An economy’s total spending:

nominal GDP =􏰀 real GDP 􏰂x aggregate price level

29
Q

Increase in nominal GDP (aggregate spending)

A
  • Rise in real GDP (economic growth)
  • Rise in the price level (inflation).
  • In either case, higher spending shifts money demand to the right, raising the equilibrium interest rate
30
Q

transaction technologies effects in Nominal GDP

A
  • the methods that people use to obtain money and spend it.
  • Transaction technologies evolve over time, changing the amount of money that people wish to hold.
31
Q

Factors That Explain Differences Among Interest Rates

A
  • Maturity (term)
  • Default risk
  • Liquidity
  • Taxation
32
Q

what is “Term structure of interest rates”?

A
  • Relationships among interest rates on bonds with different maturities
33
Q

Expectations theory of the term structure

A
  • the “n” period interest rate is the average of the current one-period rate and expected rates over the next n 􏰅- 1 periods
34
Q

Expectations Theory of the term structure (formula)

A

in(t) = 1/n . [i1 (t) +􏰁 Ei1 . (t +􏰁 1) +􏰁 … 􏰁+ Ei1 . (t + n - 1)]

  • E means “expected.”
  • “in(t)” be the interest rate on an n-period bond in period t
  • “n” stand for maturity
  • “t” stand for term (period of loan - the year)
35
Q

what is Term premium (t) ?

A
  • It is a extra return on a long-term bond that compensates for its riskiness;
  • tn denotes the term premium on an “n” period bond
36
Q

The Expectation Theory with a Term Premium (formula)

A

in(t) = 1/n . [i1 (t) 􏰁+ Ei1 (t +􏰁 1) 􏰁+. . .􏰁+ Ei1 (t 􏰁+ n 􏰅- 1)] +􏰁 r

  • “E” means“expected.”
  • “in(t)”be theinterest rateon an n-period bond in period t
  • “n” stand for maturity
  • “t” stand for term (period of loan - the year)
  • “r” stand for Premiun
37
Q

what is the meaing of “Yield curve” ?

A
  • it is a progressive line in a graph that compare interest rates on bonds of various maturities at a given point in time
38
Q

Equation Yields: formula

A

in (t) = i1 (t) + rn

  • “in(t)” be the interest rate on an “n” period bond in period t
  • “n” stand for maturity in year
  • “t” stand for term (period of loan - the year)
  • “r” stand for Premiun
39
Q

Inverted yield curve:

A
  • downward-sloping yield curve signifying that short- term interest rates exceed long-term rates
40
Q

How is posible to forecast Interest Rates ?

A
  • The expected path of interest rates determines the shape of the yield curve
  • the yield curve tells us about the expected path of rates
  • so the inverse of the yield help to forecast the interest rate.
41
Q

Sovereign debt:

A
  • bonds issued by national governments
42
Q

what are the Bond-rating agencies?

A
  • firms that estimate default risk on bonds
  • Rating agencies summarize their judgments with a grade for each coun- try’s debt.

For example, Standard & Poor’s gives ratings from AAA (triple A, the highest) to D (the lowest).

  • Sometimes a plus or minus is added to the letter grade
43
Q

Sovereign Debt Ratings: (example 2010)

A
44
Q

what is consider junk bond ?

A
  • corporate bond with an S&P rating below BBB
45
Q

what is “High-yield spread:”?

A
  • difference between interest rates on BBB and AAA corporate bonds with 10-year maturities
46
Q

Municipal bonds:

A

bonds issued by state and local governments

Money, Banking and Financial Markets (14 decks)

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