Chapter 6 Lecture Notes Flashcards
(55 cards)
Fundamental Factors Affecting the Cost of Money
- Production opportunities
- Time preference for consumption
- Risk
- Inflation
When are short-term interest rates prone to rise?
During booms
Why do short-term interest rates rise during booms?
Firms need capital so higher demand pushes rates up, and inflationary pressure tries to increase rates
When do short-term interest rates typically fall?
During recessions
Why do short-term interest rates normally fall during recessions?
There is less demand for credit, the rate of inflation decreases, and the FED often lowers rates to stimulate economy
Which interest rates have a higher correlation with inflation?
Short-term interest rates
What was the inflation average from 1913 to 2019?
2.96%
What was the inflation average from 2000 to 2019?
2.08%
What was the inflation average from 1990 to 2019?
2.31%
What inflation rate do you use in problems?
3%
What happens if there is massive inflation?
Supply chain issues
When are higher rates of return expected?
With riskier investments
Who controls short term interest rates?
The FED
How should short-term interest rates be described?
More volatile
How should long-term interest rates be described?
As an average
They lag behind short-term rates
Yield equation
k=k* + IP + DRP + LP + MRP
k
Quoted, nominal, interest rate
k*
REAL risk-free rate of interest
kRF
Nominal, risk free rate of interest (k*+IP)
IP
Inflation premium
DRP
Default risk premium
LP
Liquidity premium
MRP
Maturity risk premium (exists on long-term bonds because of interest rate risk)
Interest Rate Risk
The fluctuation of the price of a long-term bond when interest rates change
