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Interest Rate 1 Interest Rate Interest Rate 2 Interest Rate What is the interest rate? Explain the loanable funds theory of interest rates. The basic price that equals to the demand for, and supply of loanable funds in the financial markets is the interest rate. Borrowed assets include consumer goods, cash, and large assets. Large assets include property such as a building or a car. Interest is basically the charge or rental fee for the user of said asset. A “lease rate” refers to the interest rate of large assets such as a building or car. The loanable funds are related directly to the interest rates and total amount of the funds that are in circulation throughout the financial market periodically. Furthermore, interest rates will fall if the supply of funds increase or the holding demand remains constant. What are the two basic sources of loanable funds? The primary source of loanable funds is current savings in a depository institution. Savings are supplied from all sectors of the economy. Furthermore, the majority of savings slow through U.S. financial institutions. Savings can be accumulated by individual effort or through contractual savings programs. Contractual savings programs include purchasing whole life or endowment insurance policies and/or repaying installment or mortgage loans. Another basic source of loanable funds is the Expansion of deposits by depository institutions. This source of loanable funds are created by the banking system. Banks and other depository institutions create deposits which become the most vastly used form of money in the U.S. economy and it channel savings to borrowers. Net additions to the money supply are a source of loanable funds. Loanable funds drop below the level of current savings when the money supply contracts. Interest Rate 3 What are some of the major factors affecting the supply of loanable funds? There is multiple factors that affect the supply of loanable funds. Factors have the nature of increasing as the interest rates rise. The consequence of the effects is minimal when compared to other factors that influence the volume of savings and the opportunity for the banking system to expand deposits. What are the determinants of market interest rates? Market interest rates are determined by several factors. Primarily, the interest rate(s) that we view in the marketplace are called nominal interest rates because there is a premium included for potential peaks in the inflation rate. Nominal interest rate is also not free from the risk of default so the borrower is subject to a default risk premium. When there is no inflation expected we experience the real rate of interest. The real rate of interest is the interest rate on a risk-free financial debt instrument. Describe the three types of U.S. Treasury securities. How do interest rates affect your personal finances? Treasury bills bear the most limited maturities of Federal obligations. Treasury bills are normally issued for 90 days, and have the possibility to extend to 182 days. Treasury bills in particular are issued at auction every four weeks when matured. Issues of Treasury bills are offered weekly by the Treasury to reimburse part of the total volume of maturing bills. Essentially, 90 day Treasury bills mature and are extended in 13 weeks. Every week there is a 1/13th portion of the bill that is refunded. Interest Rate 4 Treasury notes are normally issued at particular interest rates when matured for over a year but never more than ten years. These intermediate-term federal obligations are mostly held by commercial banks Treasury bonds can be issued with any maturity but normally contain a maturity in excess of five years. Treasury bonds present interest at said rates. Most complications of these bonds are paid off or callable by the government throughout several years before their maturity. Treasury bonds can not mature for longer than 30 years. Buying and selling of Treasury bonds by dealers in maintain the active market in the government. Interest Rate 5 References Investopedia. (2010). Interest Rate. Retrieved August 4, 2010 from http://www.investopedia.com/terms/i/interestrate.asp Melicher, R.W. & Norton, E.A. (2005). Introduction to institutions, investments, and management. (12th ed.). Hoboken, NJ: Wiley.