MBB11

2. Money, Banking,
and Business
Lecture 10
Interest Rates
and Bond Prices

3. Questions?

5. What determines
market interest rates?
Supply and Demand

6. Loanable Funds $
%
Interest
Rate
Supply
Demand
households
business
government
foreign
households
business
government
foreign
FED

7. Loanable Funds $
%
Interest
Rate
Supply
Demand
Shortage

8. Loanable Funds $
%
Interest
Rate
Supply
Demand

9. Interest rates are a
function of GDP and
the Money Supply
i = f(Y,M)
+ -

11. Inflation and
Interest Rates
nominal
real
nominal = real + inflation
10% = ? + ?

12. Inflation and
Interest Rates
nominal
real
nominal = real + inflation
10% = 4% + ?

13. What would you pay
for $100 a year
forever?
Price =
payment
rate

14. A bond that never
matures
Consol
Perpetual

15. Government decides when
to redeem

16. Summary
compounding & discounting
interest rates and bond prices
determinants of interest rates
nominal versus real
rates and business cycle

18. The Structure
of Interest Rates
Simplifying
Assumptions

19. Spread
differences between
two instruments

20. Rate
Time

21. Rate is a function of
maturity
credit risk
liquidity
taxes

22. 0%
2%
4%
6%
8%
10%
12%
14%
16%
1 2 5 10
June 1, 2003
May 7, 2007
January 29, 1993
January 16, 1981
Term to Maturity
Yield
February 2, 2018
1.88 - 2.84

23. Maturity
rates over the life of
the instrument