Loanable funds theory explains interest rates and interest rate movements
Views level of interest rates in financial markets as a result of the supply and demand for loanable funds
Domestic and foreign households, businesses, and governments all supply and demand loanable funds
2- McGraw-Hill/Irwin
12.
Supply and Demand of Loanable Funds 2- McGraw-Hill/Irwin Interest Rate Quantity of Loanable Funds Supplied and Demanded Demand Supply
13.
Shifts in Supply and Demand Curves change Equilibrium Interest Rates 2- McGraw-Hill/Irwin Increased supply of loanable funds Quantity of Funds Supplied Interest Rate DD SS SS* E E* Q* i* Q** i** Increased demand for loanable funds Quantity of Funds Demanded DD DD* SS E E* i* i** Q* Q** Interest Rate
14.
Determinants of Interest Rates for Individual Securities
i j * = f(IP, RIR, DRP j , LRP j , SCP j , MP j )
Inflation ( IP )
IP = [( CPI t+1 ) – ( CPI t )]/( CPI t ) x (100/1)
Real Interest Rate ( RIR ) and the Fisher effect
RIR = i – Expected ( IP )
2- McGraw-Hill/Irwin
15.
Determinants of Interest Rates for Individual Securities (cont’d)
Default Risk Premium ( DRP )
DRP j = i jt – i Tt
i jt = interest rate on security j at time t
i Tt = interest rate on similar maturity U.S. Treasury security at time t
Liquidity Risk ( LRP )
Special Provisions ( SCP )
Term to Maturity ( MP )
2- McGraw-Hill/Irwin
16.
Term Structure of Interest Rates: the Yield Curve 2- McGraw-Hill/Irwin Yield to Maturity Time to Maturity (a) (b) (c) (a) Upward sloping (b) Inverted or downward sloping (c) Flat
Long-term interest rates are geometric averages of current and expected future short-term interest rates plus liquidity risk premiums that increase with maturity
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