Effects of Interest Rates on Businesses

6 Key excerpts on "Effects of Interest Rates on Businesses"

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  eBook - PDF

  Financial Institutions

  Markets and Money

  • David S. Kidwell, David W. Blackwell, David A. Whidbee, Richard W. Sias(Authors)
  • 2020(Publication Date)
  • Wiley

    (Publisher)

  HOW INTEREST RATES ARE DETERMINED C H A P T E R 4 The Level of Interest Rates C H A P T E R 5 Bond Prices and Interest Rate Risk C H A P T E R 6 The Structure of Interest Rates P A R T 2 Glowimages/Getty Images C H A P T E R F O U R The Level of Interest Rates IF YOU READ THE Wall Street Journal or watch CNN on a regular basis, you know that interest rates are constantly in the news. During the 2007–2009 recession there were fears that interest rates would become so low that the Fed’s ability to stimulate the economy might be jeopard- ized. Journalists sounded the alarm over the perils of low interest rates as rates hov- ered near zero and consumers complained that they were earning almost no inter- est on their savings accounts. However, with the economy stalled at 9.5 percent unemployment, the Fed continued to pump more money into the financial sys- tem in an effort to reinvigorate the stag- nant economy. The fundamental question addressed by this chapter is, “Why are interest rates considered such an important economic variable?” They’re important because they directly affect consumer and busi- ness spending. Interest rates are the cost of borrowing someone else’s money to purchase goods and services. The money must be paid back at a later date and the total cost of any credit purchase is the price of the product plus the interest payments. Thus, when interest rates are high, purchases become more expensive, business and consumer spending slows down, inflation is typically curbed, and economic expansion and job creation are choked off. In contrast, lower interest rates tend to encourage spending by consum- ers and businesses and to stimulate busi- ness expansion and job creation; however, under certain conditions, lower interest rates can overstimulate demand, which in turn can lead to inflation. This chapter explains the role of interest rates in the economy and provides a basic explanation of the fundamental determi- nants of interest rates.

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  Handbook of Singapore — Malaysian Corporate Finance

  • Tan Chwee Huat, Kwan Kuen-Chor, Tan Chwee Huat, Kwan Kuen-Chor(Authors)
  • 2014(Publication Date)
  • Butterworth-Heinemann

    (Publisher)

  Chapter 3 Interest Rates and Credit Mohamed Ariff 3.01 Introduction Financial institutions and markets discussed in the last chapter can be thought of as a loosely organized network for dealing with loanable funds in an economy. The loanable funds form the potential credits available to economic agents, namely, the firms, the government and the individuals. We turn our attention to understanding how interest rates determine the amount of loanable funds available as credits for economic activities. Interest rates may be thought of as the cost of borrowing the funds. Institutions provide a myriad of financial services such as lines of credit, term loans, negotiable certificates of deposits (NCDs), etc at a cost to creditors for making the funds available. Some organizations such as the companies listed in the organized exchanges and the government can issue financial instruments at stated or implied cost for having access to funds. This chapter attempts to describe this process by examining how the interest rates are determined in the market. An understanding of this process is very important to investors since interest rates will affect the outcomes of various investment activities of firms and individuals. 3.02 Interest Rates Business organizations and the government are the biggest borrowers of funds: the former require funds for undertaking real investments, and the latter for developing the economy and the social structure (education for example). Firms are faced with a number of profitable opportunities which will (1) extend the life of existing productive facilities and (2) offer new opportunities for investment which provide future benefits. These opportunities, let us call them investment schedules, are the objects of choice. Firms bid for funds in the market to undertake investments. Figure 3.1 illustrates the process of estimating the benefits of the investment schedules against the cost of getting these funds: management 39

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  eBook - PDF

  CFIN

  • Scott Besley, Eugene Brigham, Scott Besley(Authors)
  • 2021(Publication Date)
  • Cengage Learning EMEA

    (Publisher)

  This system is represented by interest rates, or the cost of money, which permits those borrowers who are willing to pay the rates that prevail in the financial markets to use funds provided by others. In this chapter, we describe basic concepts associated with interest rates, including factors that affect rates and methods for forecasting them. Yield 5 Total dollar return Beginning value 5 Dollar income 1 Capital gains Beginning value 5 Dollar income 1 sEnding value 2 Beginning valued Beginning value Equation 5.1 101 CHAPTER 5: The Cost of Money (Interest Rates) Copyright 2022 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. consumption, (3) risk, and (4) inflation. To see how these factors influence an economy, imagine an isolated is- land community where the people survive by eating fish. They have a stock of fishing gear that permits them to live reasonably well, but they would like to have more fish. Now suppose Mr. Crusoe has a bright idea for a new type of fishnet that would enable him to increase his daily catch substantially. It would take him one year to perfect his design, build his net, and learn how to use it efficiently. Mr. Crusoe probably would starve be- fore he could put his new net into operation. Recogniz- ing this problem, he might suggest to Ms. Robinson, Mr. Friday, and several others that if they would give him one fish each day for one year, he would return two fish per day during all of the following year.

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  Fundamentals of Corporate Finance

  • Robert Parrino, David S. Kidwell, Thomas Bates(Authors)
  • 2016(Publication Date)
  • Wiley

    (Publisher)

  As unemployment begins to decrease, the economic future looks bright and consumers begin to buy more homes, cars and other durable items on credit. As a result, the demand for funds by both businesses and consumers increases, driving interest rates up. Also, near the end of the expansion, the rate of inflation begins to acceler-ate, which puts upward pressure on interest rates. At some point, the central bank becomes concerned over the increasing inflation in the economy and begins to tighten credit, which further raises interest rates, slowing the economy down. The higher interest rates in the economy choke off spending by both businesses and consumers. In addition, with an inflation target to meet, such as the one discussed at the start of the chapter for the European Central Bank, monetary tightening will take place, which will drive up interest rates. During a recession, the opposite takes place; businesses and consumers rein in their spending and their use of credit, putting downward pressure on interest rates. To stimulate demand for goods and services, the central bank will typically begin to make more credit available through a looser monetary policy. The result is to lower interest rates in the economy and encourage business and consumer spending. Also notice in Exhibit 2.6 that periods of business expansion tend to be much longer than periods of contraction (recessions). Looking across economies, it is noticeable that the periods of economic expansion have lasted considerably longer than periods of contraction. An OECD study indicates that the average length of a recession is 3.5 quarters and that of expansion is 24.5 quarters. 11 Planning Ahead by Financial Managers It is important for a financial manager to understand what factors determine the level of inter-est rates and what causes interest rates to vary over the business cycle.

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  Money and Banking

  An International Text

  • Robert Eyler(Author)
  • 2009(Publication Date)
  • Routledge

    (Publisher)

  Something we will explore in depth when we talk about money demand later is the idea of the interest rate as the opportunity cost of having cash in your pocket. This relationship between the quantity of cash or liquidity demanded and the interest rate is of key importance to a great deal of macroeconomic theories but also to monetary and fiscal policy in practice. The way consumers react to changes in interest rates paid on their cash holdings changes the demand for goods and services, as well as the demand for lending. However, for now the idea is simple: the interest rate is the opportunity cost of holding money in your wallet rather than in an interest-bearing account or investment.

  Measure of time preference

  It is this definition that links the three above and binds them in the household’s eyes. When you chose to consume more than your income, or consume with credit rather than paying in full, you are making a choice about your time preference to consume. The interest rate is a measure of how people prefer to consume with respect to time: if the interest rate falls, there will be marginal changes in consumption based on a smaller cost of credit. Certain households which initially would save, say $1000, now spend $100 of that $1000 and save only $900. They still save a certain amount, but it is less. The lower interest rate has triggered an incentive for them to spend on credit, or prefer to spend now than later in time.

  The cost of borrowing falls in the previous example, providing an incentive to borrow. Certain lenders must provide the loan, thus they see the interest rate as the revenue from lending, and want to take advantage of it. Finally, the borrower must demand cash in order to spend, thus the cost of holding money must also be going down at the same time, and intuitively it does. The interest rate is all four of these ideas simultaneously, and must be for financial markets to work correctly. We will see later that the interest rate’s measure of time preference characteristic makes the entire economy work correctly.

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  The Pure Theory of Capital

  • F. A. Hayek, Lawrence H. White(Authors)
  • 2019(Publication Date)
  • Routledge

    (Publisher)

  5 To every increase in the demand for one commodity (or other type of asset) there would correspond an exactly equal decrease in the demand for another kind of commodity. That is, prices would be determined in the same way as in the imaginary barter economy. And, in particular, the demand for investment goods would be exactly equal to that part of their assets which people did not want to have in the form of consumers’ goods. The supply of funds not spent on consumers’ goods would become equal to the demand for such funds at a rate of interest corresponding to the rate of profit as determined by the given prices. There would be differences between the rates of profit people expected to earn in their own businesses and the rates of interest at which they would be willing to lend and to borrow, corresponding to the different degrees of risk. But the net rate of interest would tend to be equal to the net rate of profit. And the relative prices of the various types of goods, and therefore the price differences, would depend solely on the relation of the proportions in which people distributed their money expenditure between consumers’ goods and capital goods to the proportions in which these two types of goods were available.

  Influence of Monetary Changes on Rate of Interest

  While this would undoubtedly be the position once equilibrium had been established, it is one of the oldest facts known to economic theory that changes in the quantity of money, or changes in its ‘velocity of circulation’ (or the ‘demand for money’), will deflect the rate of interest from this equilibrium position and may keep it for considerable periods above or below the figure determined by the real factors. This fact has scarcely ever been denied by economists, and since the time of Richard Cantillon and David Hume6 it has been the subject of theoretical analysis which has been further developed in more recent times,7 particularly by Knut Wicksell and his followers.8 But it has also given rise to a recurrent scientific fashion, from John Law9 down to L. A. Hahn10 and J. M. Keynes, of regarding the rate of interest as being solely dependent on the quantity of money and the varying desires of people to keep certain balances of money in hand.

  We are here not primarily concerned with the transitory or purely dynamic effects of monetary changes on the rate of interest. But if it is true—as we must assume in the light of all evidence—that changes in the quantity of money affect the rate of interest, there must exist, even in equilibrium conditions, some relationship between the quantity of money people want to hold and the rate of interest. It is this relationship which we must first try to elucidate.

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