BFMS L02 Theory And Framework Of Interest Rates

 BFMS L02 Theory And Structure Interesting Rates Dissertation

Banking, Economic Markets

and Systems

Arranged - two

Theory and Structure appealing rates

S C Narayan

IIMB PCN BFMS L02

1

Loanable Funds theory

" Marketplace interest Rate can be

determined by the factors

that control the provision and

with regard to loanable funds”

IIMB PCN BFMS L02

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one particular

Demand for Loanable Funds

• Household with regard to loanable funds

– As household income rises, so does sequel debt

– Inverse relationship between demand for lonable funds

and interest rate

• Organization demand for loanable funds

– Inverse romantic relationship between demand for lonable funds

and rate of interest

• Federal government demand for loanable funds

– Interest inelastic since asking for to meet shortfall

• International demand for loanable funds

– Country A issues securities to buyers of country B

• Total With regard to lonable money Da =

Dh + Db + Dg + Df

IIMB PCN BFMS L02

a few

Supply of Loanable Funds

• Household sector is the greatest followed by

Government and Business (Sa)

• Directly proportionate to interest levels

_______________________________________

In equilibrium, De uma = Social fear

• And the interest rate at this point is is known as

‘equilibrium interest rate'

• Enhancements made on demand or perhaps supply causes a change in

‘equilibrium fascination rate'

IIMB PCN BFMS L02

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2

Fisher Effect

• Offers an added explanation to the loanable

money theory

• Nominal Interest rate

– Makes up for decreased purchasing electrical power

– Provides a premium for foregoing present consumption

• (1+In ) = (1+ir)*(1+E(i))

• Which is often simplified as

In sama dengan ir + E(i)

where

in is the Nominal rate of interest

ir may be the Real rate of interest

E(i) is definitely the Expected pumpiing

• Since ir cannot be negative, bigger inflation tends to

push up interest levels

IIMB PCN BFMS L02

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Key issues impacting Interest rates

• Impact of Inflation

• Impact of budget deficit

• Effect of foreign interest rates

IIMB PCN BFMS L02

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3

Term Structure appealing rates

• Relationship among term to maturity and

annualised yield

• ‘Pure Expectations' theory

• ‘Liquidity Premium' theory

• ‘Segmented Markets' theory

IIMB PCN BFMS L02

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‘Pure Expectation' theory

• Yield curve: The relationship between deliver (real return) and tenor

• Presume yield contour is level

• Assume expectation is ‘interest charge will rise'

• Savers (Investors) will invest in short-term securities, because they can buy long term investments when the

interest levels rise

• Hence surplus in short term money, that will drive

interest rates down at the short end

• Debtors (Issuers of security) will certainly prefer to drift long term securities, as they can lock in with the current low rates

• This decreases demand for short-run funds and will drive

interest rates down at the short end.

• Therefore the deliver curve could pivot upwards

• Look at scenario and implications if perhaps expectation is

‘Interest costs will fall'

IIMB PCN BFMS L02

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some

The frontward rate

•

Hypothesis: Entrepreneur would want a two 12 months security to offer a return that is certainly similar to the expected return by investing in two consecutive 12 months securities

• (1 & ti2 )2 = (1 + ti1 ) (1 + t+1r1 )

wherever

• ti2 = the known annualised interest rate of the two season security as of time t

• ti1 = the known annualised interest rate of your one year secureness as of period

•

t+1r1 = the one year interest that is anticipated as of time t+1 (i. e. 12 months ahead)

•

Therefore , t+1r1

= [ (1 + ti2 )2 as well as (1 & ti1 ) ] – 1

•

The word t+1 1 is referred to as the forward price and represents the market's outlook of long term interest rate

ur

IIMB PCN BFMS L02

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‘Liquidity Premium' Theory

• Temporary maturity suggests ‘greater

liquidity'.

• Investors willing to maintain longer term investments

if there is a ‘premium' presented on the produce

• Fluidity premium enhances the slope from the

yield shape

IIMB PCN BFMS L02

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five

‘Segmented market' theory

• Investors and...