1) Why did interest rates change over the past year?
2) What is Interest rate elasticity?
3) How would an increase in government spending affect the rate of interest?
4) What happens to interest rates during a recession?
5) How are expected interest rates linked to an expectation of economic growth and inflation?
6) What is the link between the nominal rate of interest and real rate of interest?
7) When stock values experience a drop and investors sell, interest rates usually decline. How does the selling of stocks lead to lower interest rates?
8) How would expectations of higher global oil prices affect supply and demand for loan-able funds and interest rates in the United States? Will the change apply to the interest rates of other countries in the same way?
9) Why might we expect interest rate movements of established countries to have a higher correlation in recent years compared to historical measures?
10) How does government borrowing and the national deficit level affect interest rates?
Write down your responses here or there and I'll go find the answers. By the way, if you have any questions of your own or want to add a question to the list please do. There are no wrong answers, only right ones!
BONUS Questions!
A) What is Interest Rate Risk? and B) Who is at risk?
Answers!
1) The Fed began to wind down Quantitative Easing which is a reduction in the amount of Treasuries they purchase and amount of cash going into the economy. This is like taking your foot off of the gas when driving a car. It does not include braking to slow down which is akin to raising interest rates. Although the economy will perceive rising rates when QE winds down. Look at the housing market for example. Rates are scheduled to increase in 2015, of course there is no guarantee in future Fed actions.
2) Interest elasticity of demand represents the change in the quantity of loan-able funds demanded in response to a change in interest rates.
3) The governments demand for money would create a demand for loan-able funds which would have a tendency to push interest rates up.
4) During a recession companies tend to reduce spending and borrowing. The result is a reduction in demand for loans and a drop in interest rates.
5) Interest rates in the future should increase if economic growth and inflation are expected to rise; decrease if economic growth and inflation are expected to decline.
6) Nominal interest rate is the quoted rate while the real rate equal the nominal rate minus the rate of inflation or nominal rate = real rate + inflation. We are not including any other risk premiums here.
7) When stocks go through a sell-off the money typically goes into money market accounts creating an abundance of loan-able funds and thus lowering interest rates.
8) Expectations of higher oil prices creates concern for higher inflation. Since higher inflation can increase interest rates, it will cause an expectation of higher interest rates in the U.S. Firms and government agencies may borrow more funds before prices increase and before interest rates increase. Consumers may use their savings to buy products before the prices increase. Therefore, the demand for loan-able funds should increase, the supply of loan-able funds should decrease, and interest rates should increase.
The impact of higher global oil prices in other countries is not necessarily the same. If the country produces its own oil, it can set the oil prices in its respective country. If it can prevent high oil prices in its country, then the prices of products (gasoline) and services (transportation) may not be affected. Therefore, interest rates may not be affected.
9) Interest rates among countries are expected to have a higher correlation in recent years because financial markets are more geographically integrated. More international financial flows will occur to capitalize on higher interest rates in foreign countries, which affects the supply and demand conditions in each market. As funds leave a country with low interest rates, this places upward pressure on that country’s interest rates. The international flow of funds causes this type of reaction. Also known as carry trade.
10) When the government has a high borrowing deficit, the national interest payments on the loans are higher which reduces the amount of funds available for lending, driving up the rate of interest. When the deficit is low, there are more funds available and interest rates should be lower.
BONUS Answers!
A) Interest rate risk is a time based risk that occurs when rates fluctuate. Since rates will change more often over a long period of time relative to a shorter period, there is a premium added to account for the risk. This is one of the reasons the 10-year treasury has a higher return than a 6-month treasury. Homeowners at one time had to pay a penalty if they paid off their mortgage early.
B) Any person or organization that invests in the long-term faces the chance that interest rates will change. Insurance companies, pensions, and many investors who purchase bonds encounter similar patterns of risk.
