Lecture 5 Flashcards
loanable funds = ?
money made available to borrowers by lenders
when will lenders supply funds?
lenders will only supply funds under the condition that they’re likely to receive a nice return
an amount greater than what they lent
what intention do borrowers have when borrowing funds?
borrowers demand funds often with the intention to reinvest the loan and earn a satisfactory return
higher than the cost of their loan
both parties (borrowers and lenders) have what intention before entering a transaction?
to attain a profit
interest rate = ?
how much it will cost you to take a loan right now
equilibrium interest rate = ?
interest rate at which supply matches demand
loanable funds theory = ?
interest rates relate to and are dictated by the supply and demand for loanable funds
two sources of loanable funds = ?
savings from businesses/individuals (loan from friends & firms)
deposits by banks (loan from bank)
factors affecting the supply of loanable funds = ?
the volume of savings
deposits given by the bank (the rate at which banks are issuing loans)
liquidity attitudes (how willing people are to lend their money)
factors affecting the demand for loanable funds?
changes in long term and short term interest rates
market interest rate (r) = ?
nominal interest rate in the market for a debt instrument
real rate of interest (RR) = ?
interest on a debt instrument without taking into account inflation
investors expect a certain level of return to incentivise them to invest their money instead of saving it
inflation premium (IP) = ?
additional expected return to compensate for expected inflation over the life of the debt instrument
market interest rate (r) = ?
equation
r = RR (real rate of interest) + IP (inflation premium)
r = RR + IP
risk-free interest rates only contain what?
risk free interest rates only contain a real rate of interest component and an inflation premium for debt instruments that have no additional risk components
default risk premium (DRP) = ?
additional expected return to compensate for the risk of the borrower defaulting on the loan principal repayment
maturity risk premium (MRP) = ?
additional expected return to compensate for the risk of the interest rate rising over the debt instrument’s life
liquidity premium (LP) = ?
additional expected return to compensate for the debt instrument potentially being hard to sell at a good price
what are the various components of market interest rate?
r - market interest rate
RR - real rate of interest
IP - inflation premium
DRP - default risk premium
MRP - maturity risk premium
LP - liquidity premium
what is the equation for calculating market interest rate when all risk components are in effect?
r = RR + IP + DRP + MRP + LP
market interest rate is calculated by…?
adding all the premiums to real rate of interest
what causes negative interest rate to occur?
when a financial institution or government charge interest rather than pay interest to savers
term structure of interest rates = ?
relationship between interest rates and the time to maturity for debt instruments of comparable quality
yield curve = ?
graphic representation of term structure of interest rates at a point in time
