Interest rates

Question 1

most accurate measure of an interest rate

Answer 1

yield to maturity

Question 2

loanable funds approach definition

Answer 2

• This treats the risk-free interest rates as an outcome of the forces of demand & supply in financial markets.
• Modelled by supply & demand curves

Question 3

(LF) which direction do the supply and demand curves slope

Answer 3

demand curve slopes down and supply curves slope up

Question 4

where does the equlibrium rate sit

Answer 4

at the intersection of the demand and supply curves

Question 5

effect of increase in demand from borrowers for LF curve

Answer 5

Demand increases by shifting to right

-interest rate increases

Question 6

effect of increase in money supply on LF curve

Answer 6

supply increases by shifting to the right

-interest rate decreases

Question 7

effect of real savings in community decreasing on LF Curve

Answer 7

supply decreases and shifts to the left.

-Interest rate increases

Question 8

effect of real capital inflows from off shore on LF curve

Answer 8

supply increases which decreases the interest rate.

Question 9

bank decreases money supply

Answer 9

supply decreases which causes interest rates to rise

Question 10

normal yield curve

Answer 10

upward sloping, positive

-higher interest rates for L/T

Question 11

inverse yield curve

Answer 11

downward sloping

-higher S/T rates, declining out to the L/T

Question 12

flat yield curve

Answer 12

may indicate that interest rates are in transition or stable

Question 13

humped yield curve

Answer 13

immediate liquid conditions but anticipated temporary tightness in the near future

Question 14

The 3 theories that explain term structure of interest rates?

Answer 14

1) Unbiased (pure) expectations theory
2) Liquidity premium
3) Market segmentation theory

Question 15

Key details regarding market segmentation theory

Answer 15

• rejects two assumptions
• which suggests market participants operate essentially in one maturity band
• this is determined by their sources & uses of funds

Question 16

key details of liquidity premium

Answer 16

-suggests that investors desire extra risk premium for compensating them for holding longer term sercurities

Question 17

key features of unbiased expectations theory

Answer 17

• unbiased expectations theory assumes that everyone correctly anticipates interest changes
• suggests that S/T rates implied by yeild curve are unbiased estimates of the market consensus of future rates

-normal yield curve will
result from expected short-term rates to be higher than current
short-term rates

-inverse yield curve will result from expected short-term rates to be lower than current short-term rates

-humped yield curve will result from expected short-term to be
higher initially then subsequently fall in longer term.

Question 18

unbiased expectations theory normal yield curve will

Answer 18

result from expected short-term rates to be higher than current short-term rates

Question 19

unbiased expectations theory inverse yield curve will

Answer 19

result from expected short-term rates to be lower than current short-term rates

Question 20

unbiased expectations theory humped yield curve will

Answer 20

result from expected short-term to be

higher initially then subsequently fall in longer term