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FIN 3303 Chapter 2
Financial Markets - Exam 1
24
Finance
Undergraduate 4
02/15/2010

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Term
loanable funds theory
Definition
- market interest rate is determined by the factors that control supply of and demand for loanable funds
Term
household demand for loanable funds
Definition
- inverse relationship between the interest rate and the quantity of loanable funds demanded
Term
business demand for loanable funds
Definition
- depends on number of business projects to be implemented; more demand at lower interest rates
Term
government demand for loanable funds
Definition
- interest inelastic - insensitive to interest rates; expenditures and tax policies are independent of the level of interest rates
Term
foreign demand for loanable funds
Definition
- a country's demand for foreign funds depends on the interest rate differential between the two
- the greater the differential, the greater the demand for foreign funds
- the quantity of US loanable funds demanded by foreign governments will be inversely related to US interest rates
Term
supply of loanable funds
Definition
- households are largest supplier, but some supplied by government units
- more supply at higher interest rates
- supply by buying securities
- effects of the fed - by affecting the supply of loanable funds, Fed's monetary policy affects interest rates
- aggregate supply of funds
Term
impact of economic growth on interest rates
Definition
- puts upward pressure on interest rates by shifting demand for loanable funds
Term
impact of inflation on interest rates
Definition
- puts upward pressure on interest rates by shifting supply of funds inward and demand for funds outward
Term
impact of monetary policy on interest rates
Definition
- when the Fed reduces the money supply, it reduces the supply of loanable funds, putting upward pressure on interest rates
Term
impact of the budget deficit on interest rates
Definition
- 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
Term
impact of foreign flows of funds on interest rates
Definition
- interest rate for a certain currency is determined by the demand for funds in that currency and the supply of funds available in that currency
Term
what future demand for loanable funds depends upon
Definition
- foreign demand for US funds
- household demand for funds
- business demand for funds
- government demand for funds
Term
what future supply of loanable funds depends upon
Definition
- future supply by households and others
- future foreign supply of loanable funds in the US
Term
liquidity
Definition
- the ease of conversion to cash without loss of value
- the lower a securities liquidity, the higher the yield preferred by investor
Term
tax status
Definition
- investors are more concerned with after-tax income
- taxable securities must offer a higher before-tax yield
Term
term to maturity
Definition
- maturity dates will differ between debt securities
- the term strucutre of interest rates defines the relationship between term to maturity and the annualized yield
Term
explaining actual yield differentials
Definition
- small differentials can be significant
Term
yield differentials of money market securities
Definition
- securities: commercial paper, certificates of deposit, bankers acceptances
- yields are just slightly higher than the risk-free T-bills
Term
yield differentials of capital market securities
Definition
- municipal (munis) bonds have lowest before-tax yield
- treasury bonds may have higher before-tax yield than munis but have lowest after-tax yield
- corporate bonds may have highest yields
Term
pure expectations theory
Definition
- term structure is determined solely by the expectations of future rates
Term
impact of an expected increase in interest rates
Definition
- leads to an upward sloping yield curve
Term
impact of an expected decline in interest rates
Definition
- leads to a downward sloping yield curve
Term
liquidity premium theory
Definition
- investors prefer short-term liquid securities but will be willing to invest in long-term securities if compensated with a premium for lower liquidity
Term
segmented markets theory
Definition
- investors choose securities with maturities that satisfy their forecasted cash needs
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