Financial markets and institutions 6th edition free download

The shift in the supply curve creates a disequilibrium in this financial market that, when corrected results in an increase in the equilibrium interest rate, and a decrease in the equilibrium quantity of funds traded.

Monetary Expansion. One method used by the Federal Reserve to implement monetary. When monetary policy objectives are to enhance growth in the economy, the Federal Reserve increases the supply of funds available in the financial markets. At every interest rate the supply of loanable funds increases, the supply curve shifts down and to the right, and the equilibrium interest rate falls, while the equilibrium quantity of funds traded increases.

Conversely, when monetary policy objectives are to contract economic growth, the Federal Reserve decreases the supply of funds available in the financial markets. At every interest rate the supply of loanable funds decreases, the supply curve shifts up and to the left, and the equilibrium interest rate rises, while the equilibrium quantity of funds traded decreases. Economic Conditions. Finally, as economic conditions improve in a country relative to other countries, the flow of funds to that country increases.

The inflow of foreign funds to U. Accordingly, the equilibrium interest rate falls, and the equilibrium quantity of funds traded increases. Factors that affect the demand for funds utility derived from the asset purchased with borrowed funds, restrictiveness of nonprice conditions of borrowing, domestic economic conditions, and foreign economic conditions. As the utility derived from an asset purchased with borrowed funds increases the willingness of market participants households, business, etc.

Accordingly, at every interest rate the demand for loanable funds increases, or the demand curve shifts up and to the right. The shift in the demand curve creates a disequilibrium in this financial market.

As competitive forces adjust, and holding all other factors constant, the increase in the demand for funds due to an increase in the utility from the purchased asset results in an increase in the equilibrium interest rate, and an increase in the equilibrium quantity of funds traded. Conversely, as the utility derived from an asset purchased with borrowed funds decreases the willingness of market participants households, business, etc.

Accordingly, at every interest rate the demand of loanable funds decreases, or the demand curve shifts down and to the left. The shift in the demand curve again creates a disequilibrium in this financial market. As competitive forces adjust, and holding all other factors constant, the decrease in the demand for funds due to a decrease in the utility from the purchased asset results in a decrease in the equilibrium interest rate, and a decrease in the equilibrium quantity of funds traded.

Restrictiveness on Nonprice Conditions on Borrowed Funds. As the nonprice restrictions put on borrowers as a condition of borrowing increase the willingness of market participants to borrow decreases and the absolute dollar value borrowed decreases. The shift in the demand curve again creates. As competitive forces adjust, and holding all other factors constant, the decrease in the demand for funds due to an increase in the restrictive conditions on the borrowed funds results in a decrease in the equilibrium interest rate, and a decrease in the equilibrium quantity of funds traded.

Conversely, as the nonprice restrictions put on borrowers as a condition of borrowing decrease market participants willingness to borrow increases and the absolute dollar value borrowed increases.

The shift in the demand curve results in an increase in the equilibrium interest rate, and an increase in the equilibrium quantity of funds traded. When the domestic economy is experiencing a period of growth, market participants are willing to borrow more heavily.

Accordingly, at every interest rate the demand of loanable funds increases, or the demand curve shifts up and to the right. As competitive forces adjust, and holding all other factors constant, the increase in the demand for funds due to economic growth results in an increase in the equilibrium interest rate, and an increase in the equilibrium quantity of funds traded.

Conversely, when economic growth is stagnant market participants reduce their borrowings increases. Accordingly, at every interest rate the demand for loanable funds decreases, or the demand curve shifts down and to the left.

The shift in the demand curve results in a decrease in the equilibrium interest rate, and a decrease in the equilibrium quantity of funds traded. The nominal interest rate on a security reflects its relative liquidity, with highly liquid assets carrying the lowest interest rates all other characteristics remaining the same. Likewise, if a security is illiquid, investors add a liquidity risk premium LRP to the interest rate on the security.

The liquidity premium theory states that longterm rates are equal to geometric averages of current and expected short-term rates like. The market segmentation theory does not build on the unbiased expectations theory or the liquidity premium theory, but rather argues that individual investors and FIs have specific maturity preferences, and convincing them to hold securities with maturities other than their most preferred requires a higher interest rate maturity premium.

The main thrust of the market segmentation theory is that investors do not consider securities with different maturities as perfect substitutes.

Rather, individual investors and FIs have distinctly preferred investment horizons dictated by the dates when their liabilities will come due. According to the unbiased expectations theory, the one year interest rate one year from now is expected to be less than the one year interest rate today. The liquidity premium theory is an extension of the unbiased expectations theory. Loanable Funds Theory a. Supply of Loanable Funds b. Demand for Loanable Funds c.

Equilibrium Interest Rate d. Movement of Interest Rates over Time 4. Inflation b. Real Risk Free Interest Rates c. Default or Credit Risk d. Liquidity Risk e. Special Provisions or Covenants f. Term to Maturity 5. Term Structure of Interest Rates a.

Unbiased Expectations Theory b. Liquidity Premium Theory c. Market Segmentation Theory 6. Forecasting Interest Rates 7. Time Value of Money and Interest Rates a. Time Value of Money b. Lump Sum Valuation c. Annuity Valuation. Learning Goals 1. Know who the main suppliers of loanable funds are. Know who the main demanders of loanable funds are.

Understand how equilibrium interest rates are determined. Examine factors that cause the supply and demand curves for loanable funds to shift. Examine how interest rates change over time. Know what specific factors determine interest rates. Examine the different theories explaining the term structure of interest rates.

Understand how forward rates of interest can be derived from the term structure of interest rates. Understand how interest rates are used to determine present and future values. Chapter in Perspective This is the first of several chapters that familiarize students with the determinants of valuation of bonds and related securities. In this chapter the authors first focus on the economic determinants of interest rates using the flow of funds theory of interest rates.

Subsequently, unique characteristics of securities that give rise to different interest rates are discussed. This chapter has four major sections. The loanable funds theory is the most basic explanation of real risk free interest rate formation in the economy and is easily understood by students. The loanable funds theory describes general economic forces in the economy that determine the opportunity cost of funds which may be thought of as the real, riskless rate.

The next section explains why individual investments have different interest rates because of their unique characteristics. The effect of maturity on interest rates is explained in greater detail in the term structure discussion. Three of the main theories of the term structure are presented. The chapter then provides a brief example of using term structure mathematics to forecast interest rates.

The final section provides a review of basic time value calculations. The sixth edition of the text drops the discussion of calculating the effective annual rate that had been in prior editions. Key Concepts and Definitions to Communicate to Students Real riskless rates vs nominal riskless rates. Teaching Notes 1.

They are a the real riskless rate of interest that is compensation for the pure time value of money, b an expected inflation premium that is time dependent and c a risk premium for liquidity, default and interest rate risk. Loanable Funds Theory The interaction of supply and demand of funds sets the basic opportunity cost rate real riskless interest rate in the economy. The Federal Reserve estimates supply and demand of funds from households, business, government and foreign sources through its flow of funds accounts.

Flows of funds tables are available at the Federal Reserve website at www. The Federal Reserve Fed has pushed short term interest rates to near record lows in order to stimulate the economy and has pursued a policy of quantitative easing purchasing government and mortgage debt by creating money in an additional attempt to encourage spending and investment.

In mid the Fed announced it would begin gradually tapering its bond purchases although the Fed has continued to promise to keep short term interest rates low well into The predominant suppliers of loanable funds are households. Household savings rates have increased since the financial crisis. The second largest net supplier of funds is the foreign sector. The U. This reliance becomes increasingly problematic with the continued long term fall in the value of the dollar.

Household savings increase with higher interest rates and the supply curve is upward sloping with respect to interest rates. However, the main determinants of household savings are 1 income and wealth, the greater the wealth or income, the greater the amount saved, 2 attitudes about saving versus borrowing, 3 credit availability, the greater the amount of easily obtainable consumer credit the lower the need to save, 4 job security and belief about safety of the Social Security system and 5 tax policy.

In the U. As a result, the supply curve is steeper than one might expect. The instructor may wish to explain that at higher interest rates, savers do not have to save as much to hit specified future values, so savings are not that sensitive to interest rates. Where consumers put their savings is sensitive to interest rates, they move out of liquid accounts as interest rates rise as the price of foregoing higher rates of return to maintain liquidity rises.

Households apparently try to smooth consumption patterns over different levels of. As income falls they save less to maintain consumption, as income rises households save more. Other factors include the perceived riskiness of investments, near. Favorable economic conditions also increase savings by increasing income and wealth.

Note that on net the foreign sector is the second largest supplier of funds. Foreign funds suppliers examine the same factors as U. There is typically some built in demand for U. The dollar is used to price many commodities, including oil and gold; the dollar is the primary foreign currency reserve asset for many central banks and many exports are dollar denominated even if the ultimate destination is not the U.

Some feel that the dollar will lose its reserve status eventually if China continues to grow and dominate Asia and if Europe increases its commitment to growth policies while continuing to deconstruct some of their increasingly expensive social welfare programs. The time frame required for a major shift away from the dollar may be ten to twenty years or even much longer however, because China will remain far too risky for quite a while and Europe must demonstrate a commitment to growth and solve its sovereign debt problems.

China has made several moves lately to free up yuan trading. China now allows exporters to sell some of their foreign currency earnings, allows limited individual trading in its currency and allows yuan financing in international markets. China still maintains capital controls however.

These high levels of reserves are indicative of foreign central bank activity to limit the growth in the value of their currencies against the dollar. This may be done to stimulate their export sectors. The dollars are often reinvested in the U. This provides an additional source of financing to the U. Since the money is more or less automatically rechanneled into the U. This promotes overspending by U. The negative balance on the U. Salomon Center. Stern School of Business.

Pdf Herefinance. Financial Markets and Institutions, 5th. Financial Markets and Institutions, Abridged Edition.

Jeff Madura For your course and learning solutions, visit. Management of Financial Institutions Anthony Saunders and attached to the title of the property that gives the financial institution the right to sell the. Department of Finance. Kaufman Management Center.

Stern School of Business, New York? Master of Science in Finance and Banking 3. Saunders, A.