Chapter 6 Financial economics

Four most fundamental factors affecting the cost of money

1.) Production opportunities 2.) time preference for consumption 3.) risk 4.) inflation.

Interest rates paid to savers depnds on

1.)Rate of return that producers expect to earn on invested capital. 2.)Savers time preferences for currunt vs future consumption. 3.)The riskiness of the loan. 4.)Expected future rate of inflation

Which factor determines how much will be saved at different interest rates

Consumers time preferences for consumption establish how much consumption they are willing to defer and, hence, how much they will save at different interest rates.

Two items whose sum is the cost of equity

Dividends and capital gains.

Treasury bond

Has no default risk premium or liquid risk premium therefore, T1= r*+ inflation premium+ maturity risk premium

Corporate bonds

Have both defualt risk premium and liquidity risk premium therefore, Rc= r*t+IPt+mrpt+DRP+ LP

How do risk inflatiion impact interest rates in the economy

Higher risk and higher inflation leads to higher interest rates.

What is price paid to borrow debt capital called

INTEREST RATE is the price paid to borrow debt capital

Which factor sets an upper limit on how much can be paid for savings ?

Producers expected returns on their business investments.

Treasury bill

T-bill= rRF= r*+ Lp