Global Financial Markets Ch 2

True or false, non price conditions and requirements do not affect a households demand for loanable funds at every level of interest rates

False

True or false, the real risk free rate on an investment is not the percentage change in the buying power of a dollar

False

Businesses demand funds to:

Finance investments in long-term (fixed) assets (e.g. plant and equipment) and for short term working capital needs (e.g. inventory and AR) usually by issuing debt and other financial instruments.

The demanders of loanable funds, from largest to smallest are:

Financial businesses, non-financial businesses, households, governments, and foreign participants (households, businesses, and governments).

The demand for loanable funds by households reflects the demand for financing:

Homes with mortgages, durable goods (cars and appliance loans), non durable goods (education and medical loans)

What plays a major part in the determination of the value of financial instruments?

Interest rates

When interest rates are high, businesses prefer to finance investments with:

Internally generated funds (e.g. retained earnings) rather than through borrowed funds.

Future Value of a Lump Sum

The future value of a lump sum equation translates a cash flow received at the beginning of the investment period to a terminal (future) value at the end of an investment horizon

Future value of an annuity

The future value of an annuity equation converts a series of equal cash flows received at equal intervals throughout the investment horizon into an equivalent future amount at the end of the investment horizon.

What is the real risk free rate?

The interest rate that would exist on a risk-free security if no inflation were expected over the holding period (e.g. a year) of a security.

What is the market Segmentation Theory?

The market segmentation theory assumes that individual investors and FIs have specific maturity preferences, and to get them to ho,d securities with maturities other than their most preferred requires a higher interest rate.

Present Value of a Lump Sum

The present value function converts cash flows received over a future investment horizon into an equivalent (present) value as if they were received at the beginning of the current investment horizon.

Present value of an annuity

The present value of an annuity equation converts a finite series of constant (or equal) cash flows received on the last day of equal intervals throughout the investment horizon into an equivalent (present) value as if they were received at the beginning of the investment horizon.

A shift in the supply or demand curve occurs when:

The quantity of a financial security supplied or demanded changes at every interest rate in response to a change in another factor besides the interest rate.

The aggregate demand for loanable funds is:

The sum of the quantity demanded by the separate fund demanding sectors.

The aggregate supply of loanable funds is:

The sum of the quantity supplied by the separate fund supplying sectors (households, businesses, governments, and foreign agents)

What is the unbiased expectations theory?

The theory that states at a given point in time the yield curve reflects the markets current expectations of future short-term rates - e.g. in equlibrium, the return to holding a 4 yr bond to maturity = the return to holding 4 seperate 1 yr bonds

The demand for loanable funds is used to describe:

The total net demand for funds by fund users.

Explanations for the shape of a yield can fall into three categories:

The unbiased expectations theory, the liquidity premium theory, and the market segmentation theory

Factors that cause the supply curve of loanable funds to shift, at any interest rate include:

The wealth of funds suppliers, the risk of the financial security, future spending needs, monetary policy objectives, and economic conditions.

Time Value of Money

Time Value of Money is the basic notion that a dollar received today is worth more than a dollar received in the future, b/c the dollar can be invested today and earn interest

True or false, the quantity of loanable funds supplied increases as interest rates rise.

True

True or false, the supply of loanable funds from households also depends on their immediate spending needs.

True

True or false, the interest rate or return reflects that people generally prefer to consume now rather than wait until later.

True, to compensate them for delaying consumption (saving), they are paid a rate of interest by those who wish to consume more today than their current savings permit (users of funds).

Factors that cause the demand curve for loanable funds to shift include:

Utility (usefulness) derived from assets purchased with borrowed funds, the restrictiveness of non-price conditions on borrowing (fees, requirements, etc), and economic conditions (when the economy is doing well, participants are more willing to borrow).

Forward Rate

An expected or "implied" rate on a short-term security that is to be originated at some point in the future

What is the liquidity premium theory?

An extension of the unbiased expectations theory, the idea that investors will only hold the long term (the 4 yr) bond rather than the short term (1 yr) if they are being compensated with a premium b/c of liquidity risk.

The supply of loanable funds refers to:

Describe funds provided to the financial markets by net suppliers of funds

Changes in interest rates influence the performance and decision making for:

Individual investors, businesses, and governments alike

The determinants of interest rates for individual securities are:

Inflation, the "real" risk-free rate, default risk, liquidity risk, special provisions, and term to maturity

Higher interest rates can cause state and local governments to:

Postpone borrowings and thus capital expenditures

State and local governments often issue debt instruments to finance:

Temporary imbalances between operating revenues (taxes) and budgeted expenditures (road improvements, school construction, etc.

Who is the largest supplier of loanable funds in the US?

The household (consumer) sector - they supply funds when they have excess income or want to reallocate their asset portfolio holdings.

Who are the suppliers of loanable funds from largest to smallest?

The household sector, financial businesses, foreign investors, some governments, and non-financial businesses.

What is the loanable funds theory?

The loanable funds theory views the level of interest rates as resulting from factors that affect the supply of and demand for loanable funds. It categorizes financial market participants - consumers, businesses, governments, and foreign participants - as net suppliers or demanders of funds.

True or false, the quantity of loanable funds demanded is higher as interest rates fall.

True

Nominal Interest Rates

the interest rates actually observed in financial markets. Also called just interest rates; they directly affect the value (price) of most securities traded in the money and capital markets, both at home and abroad.