Interest Rate Determination - Chapter 2 ( Financial institutions and markets) .pptx

Get a light idea about Interest Rate Determination. Know what Interest Rate Determination consist of. Know when, where, how to use Interest Rate Determination. Interest Rate Determination from here we will get the basic idea.

1. Interest Rate DETERMINATION ★★ Welcome to My presentation★★

2. Presented by : Sourav saha Id: 21FIN032 Department of Finance and Banking University of Barishal Sub: Financial Institutions & Markets

3. Interest Rate : The acts of saving and lending, and borrowing and investing, are significantly influenced by and tied together by the interest rate . The interest rate is the price a borrower must pay to secure scarce loanable funds from a lender for an agreed-upon time period . Interest rates, in general, reflect the cost of funds the interest rate can be viewed as the rental price for money (opportunity cost for money).

4. Interest Rate : effect of policy rate to the market interest rates depends on the structure of interest rates and the level of financial development . All business organizations or individuals are responsive to interest rate of banks and financial institutions in one-way or another. Interest rate structure is the relationship between maturity and yield in order to determine bow the bond portfolio behaves in matching the maturity structure

5. The Loanable Funds Theory of Interest: The Loanable Funds Theory of Interest is an economic theory that explains how interest rates are determined by the supply and demand for loanable funds in the financial markets. According to this theory, the interest rate is the price of borrowing funds, which is influenced by the interaction between those who want to lend (supply) and those who want to borrow (demand).

6. The Loanable Funds Theory of Interest: Key Concepts of the Loanable Funds Theory of Interest: Demand for Loanable Funds : Sources : Borrowing needs of households (for consumption and investment), businesses (for capital investment), and government deficits. Determinants : Expected profitability of investments, consumption needs, and the interest rate (lower interest rates encourage more borrowing).

7. Household demand for loanable funds refers to the borrowing needs of households in an economy. Households seek to borrow funds primarily for consumption purposes and investment in durable goods, such as homes, vehicles, and education. This demand is influenced by various factors including income levels, interest rates, and future income expectations. Consumer (household) demand is relatively inelastic with respect to the rate of interest. The Loanable Funds Theory of Interest :

8. The Loanable Funds Theory of Interest: Business demand for loanable funds refers to the borrowing needs of businesses for purposes such as financing capital investments, managing operational expenses, and pursuing growth opportunities. Businesses seek loanable funds to invest in projects that they expect will generate returns higher than the cost of borrowing, thereby contributing to their profitability and growth .

9. The Loanable Funds Theory of Interest : Government demand for loanable funds refers to the borrowing needs of governments to finance public expenditures that exceed their revenues. Governments borrow to fund various activities including infrastructure projects, social programs, defense, and to cover budget deficits. This borrowing can have significant implications for the overall economy and the financial markets.

10. The Loanable Funds Theory of Interest : Foreign demand for loanable funds refers to the borrowing needs of foreign governments, corporations, and financial institutions from the domestic financial markets of another country. This demand is driven by various factors such as investment opportunities, interest rate differentials, and economic conditions in the borrowing country.

11. The Loanable Funds Theory of Interest : Foreign demand for loanable funds refers to the borrowing needs of foreign governments, corporations, and financial institutions from the domestic financial markets of another country. This demand is driven by various factors such as investment opportunities, interest rate differentials, and economic conditions in the borrowing country.

12. The Loanable Funds Theory of Interest : Aggregate demand for loanable funds refers to the total demand for borrowing from all sectors of the economy, including households, businesses, governments, and foreign entities. It represents the overall desire to obtain funds for various purposes, such as consumption, investment, and covering deficits, at different interest rates.

13. The Loanable Funds Theory of Interest : Supply of Loanable Funds : Sources : Savings from households, businesses, and government surplus. Determinants : Income levels, time preferences for consumption, and the interest rate itself (higher interest rates encourage more saving).

14. The Loanable Funds Theory of Interest : ➤The Supply of Loanable Funds Domestic Savings. The net effect of income, substitution, and wealth effects is a relatively interest-inelastic supply of savings curve. Dishoarding of Money Balances. When individuals and businesses dispose of their excess cash holdings, the supply of loanable funds available to others is increased.

15. The Loanable Funds Theory of Interest : The Supply of Loanable Funds Creation of Credit by the Domestic Banking System. Commercial banks and nonbank thrift institutions offering payments accounts can create credit by lending and investing their excess reserves. Foreign lending is sensitive to the spread between domestic and foreign interest rates.

16. The Loanable Funds Theory of interest : Equilibrium interest rate : The interest rate at which the quantity of loanable funds supplied equals the quantity demanded. At equilibrium, the financial market is in balance, and there is no excess supply or demand for funds. Interest rates will be stable only when the economy, money market, loanable funds market, and foreign currency markets are simultaneously in equilibria.

17. The Loanable Funds Theory of Interest : At equilibrium : Planned savings = planned investment across the whole economic system Money supply = money demand Supply of loanable funds = demand for loanable funds Net foreign demand for loanable funds = net exports

18. Factors Affecting Interest Rates: Impact of Economic Growth on Interest rates 1. Slowdown in growth: Demand schedule shifts to left (demand decreases) Supply schedule may shift. 2. Increase in growth: Puts pressure on interest rates to rise due to increase in the demand schedule

19. Forces that Affect Interest Rates : Impact of Inflation on Interest Rates : Fisher Effect : states that the real rate of interest is the nominal rate less the expected inflation rate . 2. The greater the expected rate of inflation, the greater the nominal rate of interest.

20. Forces that Affect Interest Rates: C. Impact of the Budget Deficit on Interest Rates : “Crowding-out" Effect: Given a certain amount of loanable funds supplied to the market, excessive government demand for funds tends to "crowd out" the private demand for funds.

21. Forces that Affect Interest Rates: Impact of Foreign Flows of Funds on Interest Rates : In recent years, massive flows of funds have shifted between countries causing abrupt shifts in the supply of loanable funds.

22. Forecasting Interest Rates: Forecasting interest rates refers to the process of predicting future movements and levels of interest rates based on various economic indicators, market trends, and quantitative models. It is a crucial activity for investors, financial institutions, policymakers, and individuals seeking to make informed decisions about borrowing, investing, and financial planning.

23. Forecasting Interest Rates: 1. Future Demand for Loanable Funds depends on future : a. Foreign demand for U.S. funds b. Household demand for funds c. Business demand for funds d. Government demand for funds

24. Forecasting Interest Rates: 2. Future Supply of Loanable Funds depends on: a. Future supply by households and others b. Future foreign supply of loanable funds in the U.S.

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