global quiz
If there is an increase in the demand for loanable funds, BUT government regulations do not allow interest rates to change, what will be the outcome?
A shortage of loanable funds will result
If there is an increase in the demand for loanable funds, but government regulations do not allow interest rates to change, what will happen in the loanable funds market?
A shortage of loanable funds will result.
interest rates and the business cycle
confidence increases rates increase confidence decreases rates decrease
households and consumers are not optimistic
consumers are uncertain and do not buy businesses cut back and do not expand decrease in interest rates
inflationary expectations
create uncertainty
causes of decrease in demand
decrease borrowers negative business expectations decreased consumer optimism decreased deficit spending lower inflationary expectation (low price level)
economy contracts
decrease interest rates
pessimistic views of the economy
demand for funds will decrease customers will not purchase durable goods decrease in interest rates
savers
demanders of loanable bonds
negative real return
do not undertake project
business cycles
expansion, contraction, peak, trough
changes in bond market
expectations, government budget deficit
You read a report that tells you the population is falling and this is resulting in a decline in the number of borrowers in the loanable funds market. What will happen to interest rates in New Mexico and why?
The interest rate in New Mexico will fall as the demand for loanable funds falls
Market interest rates are increasing due to increased global political tensions. What impact will this have in terms of the loanable funds model?
The quantity demanded of loanable funds will decrease causing movement up the demand curve of loanable funds.
You read in The Financial Times a story that explains that market interest rates are increasing due to increased global political tensions. What impact will this have in terms of the loanable funds model?
The quantity demanded of loanable funds will decrease causing movement up the demand curve of loanable funds.
default risk premium
The rate at which a lender needs to be compensated for taking on a greater risk of default by the borrower
low price of bonds- supply
high cost of borrowing, high rates, supply few
low price of bonds- demand curve
high rate of return, buy many bonds
increased government deficit
higher interest rates increase borrowing through sale of bonds price falls increase in demand
interest rates on loanable funds
higher interest rates mean more money into loanable funds.. cost of spending is growing therefore there is more saving
economy expands
higher rates
calculate the default risk premium
interest rate on a bond - interest rate on a risk-free bond
"The opportunity cost of current consumption just decreased." In terms of the loanable funds framework, what just happened?
interest rates decreased
The opportunity cost of current consumption just increased. In terms of the loanable funds framework, what does this mean
interest rates increased
causes of decrease in supply of loanable funds
less savers -> higher interest rates lower household wealth -> higher interest rates low inflationary expectations ->low rates contractionary monetary policy -> higher rates
supply for loanable funds
optimal level of consumption is less than income households: save firms: revenue>expenditures government: tax revenue
decreased supply of loanable funds
shortage quantity supplied > quantity demanded
corporations and government
suppliers of loanable bonds
contraction
weak economy with inflation
high price of bonds- demand curve
low rate of return, buy few
high price of bonds- supply
low yield, supply more, borrow more
modern economic growth
lower interest rates lower cost of capital more funded projects more job creation
economy begins to contracts
lower rates
secondary bond market
market for bonds or other debt instruments previously issued
less developed country
more expensive to borrow weak economic growth
The Board of Governors of the Federal Reserve System has decided to pursue a contractionary monetary policy. What impact will that have in terms of the loanable funds market?
Supply of Loanable funds will decrease and interest rates will rise.
If the demand for bonds is increasing, what is happening in terms of loanable funds?
Supply of loanable funds is increasing
American households view their current retirement plans as uncertain and they decide to increase the funds that they are going to put into their retirement accounts. In terms of the loanable funds market, what will be the effect of this change?
Supply of loanable funds will increase.
Suppose you hear on the business news that the Fisher Effect is pushing down bond prices in the United States. What is happening in terms of the Loanable Funds model?
The demand for loanable funds is increasing while the supply of loanable funds is decreasing.
The state of California has had a decrease in tax revenue because of an unexpected decrease in population. As a result, they are facing a $50 Billion deficit. What impact will this have in terms of the loanable funds market?
The demand for loanable funds will increase as California borrows to cover their shortfall.
The government budget deficit increases by $450million dollars, what impact will this have in terms of the loanable funds model?
The demand for loanable funds will increase as the State of Iowa sells more bonds in the primary market.
Consumers and businesses have expectations that inflation rates are going to rise. In terms of the loanable funds framework, which best describes what will happen as a result?
There will be an increase in the demand for loanable funds and an increase in market interest rate.
As a result of uncertainty about the future of the European Union, European investors are looking for alternative investment opportunities. If these funds come to the U.S. markets, how will the loanable funds market react?
There will be an increase in the supply of loanable funds and market interest rates will fall as a result.
Suppose as a result of a strong fourth quarter performance, business profits and cash flows have increased. What will be the effect on the loanable funds markets?
There will be an increase in the supply of loanable funds and thus a decrease in the market interest rate.
causes of increase in supply of loanable funds
more savers -> lower interest rates higher household wealth -> lower interest rates high inflationary expectations -> high rates expansionary monetary policy -> lower rates
change in quantity demanded
movement along demand curve
ex poste rate
nominal - actual
ex ante rate
nominal - expected
demand for loanable funds
optimal expenditure is greater than income households: withdrawl savings firms: expenditures>investments government: budget deficit
shortage
price increases, quantity demanded decreases, supply increases
bond relationship
price= 1 / interest rate
increased supply of loanable funds
quantity demanded > quantity supplies Clear the market: lower price and rates
surplus
quantity demanded increases and quantity supplied decreases
relationship between quantity demanded and interest rates
quantity demanded increases as interest rates decrease
increase in demand for loanable funds
quantity supplied < quantity demanded (shortage) increased prices movement up the demand curve higher interest rates higher equilibrium interest rate
decrease in demand for loanable funds
surplus movement down the curve lower equilibrium interest rates
The quantity of loanable funds supplied is directly related to interest rates because as interest rates increase
the opportunity cost of household consumption increases, causing households to bring more of their after-tax income to the pool of loanable funds.
high interest rates
borrow less, cost of capital increases, NPV decreases, reduce funded projects
increase in optimism
increase in demand increase in interest rates economy expands
increase in inflationary expectation
increase in demand for loanable funds decrease in supply of loanable funds higher interest rates
positive economic expectations
increase in demand for loanable funds higher interest rates
households and businesses are optimistic
increase in demand of funds businesses increase investments increase borrowing increase capital projects
causes of increase in demand
increased borrowers increased business optimism increased consumer optimism increased deficit spending rising inflationary expectation (price level)
borrowers
inflation is a benefit to
borrowers: agencies, corporations, government
issuers of bonds
Due to a decrease in the price of petroleum products, wealth levels in Norway are falling. How might this impact corporate capital budgeting decisions in Norway?
As the supply of loanable funds decreases due to the decrease in wealth, market interest rates will rise and thus fewer corporate projects will be funded.
You read in the Financial Times that due to recent discoveries of natural gas, wealth levels in Bolivia are expected to increase rapidly. How might this impact corporate capital budget decisions in Bolivia and why?
As the supply of loanable funds increases due to the increase in wealth, market interest rates will fall and thus more corporate projects will be funded.
In order to end political unrest the Italian government significantly increased its social spending requiring it to greatly increase its amount of borrowing. At the same time, the European Central Bank that sets monetary policy for Italy was pursuing an expansionary monetary policy. If the Italian government borrowing was much larger than the ECBs monetary policy intervention, what do you expect will happen to bond price and interest rates in Italy?
Bond prices will fall and interest rates will increase.
An increase in interest rates will impact business investment spending in what way?
Business investment spending will fall as the Net Present Value of projects falls.
If businesses expect lower Net Present Value on their projects while at the same time consumer wealth levels are falling, what will happen to interest rates in terms of the loanable funds model?
Change in interest rates is undetermined as the demand for loanable funds and the supply of loanable funds are both falling.
If businesses expect higher Net Present Value on their projects and at the same time consumer wealth levels are rising, what will happen to interest rates in terms of loanable funds?
Change in interest rates is undetermined because both the demand for loanable funds and the supply of loanable funds are rising.
Due to increased political stability across Europe the relative riskiness of German bonds has decreased. What impact will this have on the German bond market and the loanable funds market in Germany?
Demand for bonds will increase and the supply of loanable funds will increase.
You have been told that your company has decided to undertake a variety of new capital projects. In terms of the loanable funds model, which of the following most likely happened?
Interest rates decreased causing an increase in the quantity demanded of loanable funds.
Firms are deciding to cut funding of projects and are thus borrowing less. In terms of the loanable funds model, which of the following most likely happened?
Interest rates increased causing a decrease in the quantity demanded of loanable funds
One of the impacts of the Arab Spring is that Libya is able to access the global financial markets. This will mean an increase in the number of foreign borrowers in Libyan financial markets as well as a large increase in the level of household wealth in Libya. From this, what you expect to happen to market interest rates and bond prices in Libya if the first change is smaller than the second?
Interest rates will decrease and bond prices will rise.
This is an expansionary monetary policy move. The Times also reported a small increase in British consumer confidence. If the size of the monetary policy action is bigger than the change in consumer confidence, what do you expect will happen to interest rates and bond prices in England?
Interest rates will fall and bond prices will increase
A state has decided to partially subsidize business hiring in the state. Firms MUST pay for the rest of the labor costs not covered by the subsidy. At the same time household wealth levels across the state are falling. What will happen to interest rates according to the loanable funds framework?
Interest rates will increase as the demand for loanable funds increases while the supply of loanable funds decreases.
Wisconsin is going to have issue bonds to fund its growing budget deficit, while at the same time out-of-state savers are pulling their savings out of Wisconsin banks. You determine the first affect will be larger than the second. According to the Loanable Funds framework, what do you think will happen to interest rates in Wisconsin and why?
Interest rates will rise as the demand for loanable funds increases more than the supply of loanable funds decreases.
As interest rates increase, American households increase the amount of funds they dedicate to retirement savings and reduce their level of spending. What impact does this have in terms of the loanable funds model?
Quantity supplied of loanable funds increase