Ch. 8

Front 1

Price that equates supply and demand for loanable funds

Back 1

Interest rate

Front 2

Interest rates are determined by the supply and demand for loanable funds in financial markets

Back 2

Role of financial markets

Front 3

1982-present (generally declining prices and interest rates)

Back 3

The current trend in interest rates

Front 4

States that interest rates are a function of the supply of and demand for loanable funds

Back 4

Loanable funds theory

Front 5

Current savings and expansion of deposits by depository institutions

Back 5

Basic sources of loanable funds

Front 6

Major factor is the level of national income

Back 6

Volume of savings

Front 7

Amount of short-term credit available depends on lending policies of depository institutions and the Fed

Back 7

Expansion of Deposits by Depository Institutions

Front 8

Refers to how lenders see the future

Back 8

Liquidity Attitude

Front 9

Interest rate that is observed in the marketplace

Back 9

Nominal interest rate (r)

Front 10

r = RR + IP + DRP

Back 10

Nominal interest rate equation

Front 11

Interest rate on a risk-free debt instrument when no inflation is expected

Back 11

Real Rate of Interest (RR)

Front 12

Average inflation rate expected over the life of the security

Back 12

Inflation Premium (IP)

Front 13

Compensation for the possibility of the borrower’s failure to pay interest and/or principal when due

Back 13

Default Risk Premium (DRP)

Front 14

r = RR + IP + DRP + MRP + LP

Back 14

Longer nominal interest rate

Front 15

Compensation for securities that cannot easily be converted to cash without major price discounts

Back 15

Liquidity Premium (LP)

Front 16

Possible price fluctuations in fixed-rate debt instruments associated with changes in market interest rates

Back 16

Interest rate risk

Front 17

An inverse relationship exists between debt instrument values or prices and nominal interest rates in the marketplace

Back 17

Reason for interest rate risk

Front 18

Interest rate on a debt instrument with no default, maturity, or liquidity risks (Treasury securities are the closest example)

Back 18

Risk-free rate of interest

Front 19

Risk-Free Rate (rf) = Real Rate (RR) + Inflation Premium (IP)

Back 19

Risk-free rate of interest equation

Front 20

Securities that may be bought and sold through the usual market channels

Back 20

Marketable Government Securities

Front 21

Issues that cannot be transferred between persons or institutions but must be redeemed with the U.S. government

Back 21

Nonmarketable Government Securities

Front 22

Obligations that bear the shortest (up to one year) original maturities

Back 22

Treasury Bills

Front 23

Obligations issued with maturities of two to ten years

Back 23

Treasury Notes

Front 24

Obligations issued with maturities usually over five years and up to thirty years

Back 24

Treasury Bonds

Front 25

Relationship between interest rates or yields and the time to maturity for debt instruments of comparable quality

Back 25

Maturity (Term) structure of interest rates

Front 26

Graphic presentation of the term structure of interest rates at a given point in time

Back 26

Yield Curve

Front 27

Shape of the yield curve indicates investor expectations about future inflation rates

Back 27

Expectations Theory

Front 28

Investors are willing to accept lower interest rates on short-term debt securities which provide greater liquidity and less interest rate risk

Back 28

Liquidity Preference Theory

Front 29

Interest rates may differ because securities of different maturities are not perfect substitutes for each other

Back 29

Market Segmentation Theory

Front 30

Occurs when an increase in the price of goods or services is not offset by an increase in quality

Back 30

Inflation

Front 31

Changes in the money supply or in the amount of metal in the money unit have influenced prices since the earliest records of civilization

Back 31

Historical Price Movements

Front 32

Occurs when prices are raised to cover rising production costs, such as wages

Back 32

Cost-Push Inflation

Front 33

Occurs during economic expansions when demand for goods and services is greater than supply

Back 33

Demand-Pull Inflation

Front 34

Caused by the expectation that prices will continue to rise, resulting in increased buying to avoid even higher future prices

Back 34

Speculative Inflation

Front 35

The tendency of prices, aided by union-corporation contracts, to rise during economic expansion and to resist declines during recessions

Back 35

Administrative Inflation

Front 36

Risk that a borrower will not pay interest and/or repay the principal on a loan according to the agreed contractual terms

Back 36

Default Risk

Front 37

DRP = r - RR - IP - MRP - LP

Back 37

Default risk equation

Front 38

Ratings of Baa or higher (Aaa, Aa, or A) that meet financial institution investment standards

Back 38

Investment Grade Bonds

Front 39

High-yield or junk bonds that have a substantial probability of default

Back 39

High-Yield Bonds