Measuring Interest Rate

5 Key excerpts on "Measuring Interest Rate"

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  eBook - PDF

  Financial Institutions, Markets, and Money

  • David S. Kidwell, David W. Blackwell, David A. Whidbee, Richard W. Sias(Authors)
  • 2016(Publication Date)
  • Wiley

    (Publisher)

  The interest rate is the price of “renting” an amount of money over a given period of time. Interest rates are similar to other prices in the economy in that they allocate funds bet- ween SSUs and DSUs. 2 Define the concept of the real interest rate and explain what causes the real interest rate to rise and fall. The real rate of interest is the fundamental long‐run interest rate in the economy. It is the market equilibrium interest rate at which desired lending by savers equals desired borrowing by producers. It is the rate of interest that prevails under the assumption that there is no inflation in the economy. 3 Explain how inflation affects interest rates. To pro- tect borrowers and lenders from unwarranted transfers in purchasing power, the nominal (or stated) interest rate on a loan equals the real rate of interest plus compensation for changes in the purchasing power of money caused by price‐level changes. This relationship is shown in the Fisher equation, which states that the nominal interest rate equals the real rate of interest plus the expected inflation rate. 4 Calculate the realized real rate of return on an investment. The return from a loan stated in terms of purchasing power of money is the realized real rate of return, which equals the nominal interest rate minus the actual rate of inflation. The realized real rate of return can be positive, zero, or negative, depending on how differ- ent actual inflation is from expected inflation. 5 Explain how economists and financial decision makers forecast interest rates. Investors and financial institutions have a keen interest in forecasting the move- ments of interest rates because of the potential impact on their wealth. Interest rate forecasting models use expected economic activity and inflation expectations to predict interest rates.

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  eBook - PDF

  Strategic Cost Fundamentals

  for Designers, Engineers, Technologists, Estimators, Project Managers, and Financial Analysts

  • Robert C. Creese, Robert Creese(Authors)
  • 2022(Publication Date)
  • Springer

    (Publisher)

  PART II Tools for Economic Evaluations 77 C H A P T E R 6 Fundamental Definitions, Terms, and Concepts for Technical Economic Evaluations 6.1 INTRODUCTION The previous chapters have focused on macro-concepts such as financial statements, profits and cash flows, the Purcell Diagram, breakeven analysis, ABC and time-based evaluations, estimat- ing ranges, and accuracies. Now the micro-concepts need to be presented in detail so that the expressions developed and methods applied using these items in the following chapters will be better understood. The primary focus of this chapter will be on interest, the various types of interest, inflation, constant and current currency, and exchange rates. This material is available in many references on engineering economy and much of this is based upon materials developed for short courses given in the past [1–3] and a book [4] published based on the materials in these short courses. 6.2 FUNDAMENTAL TERMS RELATED TO INTEREST CALCULATIONS 6.2.1 INTEREST AND INTEREST RATE There are many types of interest and two primary definitions of interest are the rate charged for the investment of capital and the return rate for the investment of capital. (1) The cost for the use of capital which is also referred to as the time value of money. (This is the view of the borrower who considers it as a cost or rate for the use of the capital borrowed.) (2) The monetary return or rate of return which is necessary to divert money into long-term investments. (This is the view of the lender who considers it as a rate of return on the investment.) 78 6. FUNDAMENTAL DEFINITIONS, TERMS, AND CONCEPTS The interest rate is the ratio of the interest amount accrued in the time period to the amount owed at the start of that period. There are two major types of interest commonly used and they are simple interest and compound interest. Simple Interest Simple interest is the interest rate that determines the interest amount only on the principal amount.

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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)

  2 Define the concept of the real interest rate and explain what causes the real interest rate to rise and fall. 3 Explain how inflation affects interest rates. 4 Calculate the realized real rate of return on an investment. 5 Explain how economists and financial decision makers forecast interest rates. 6 Explain how an expected currency change can impact interest rates. 108 4.2 The Real Rate of Interest 109 4.2 THE REAL RATE OF INTEREST The real rate of interest is one of the most important economic variables in the economy. It is the rate of interest determined by the returns earned on investments in productive assets (capital investment) in the economy and by individuals’ time preference for consump- tion. The factors that determine the real rate of interest are the underlying determinants of all interest rates observed in the economy. For this reason, an understanding of the real rate of interest is important. The real interest rate is determined in the absence of inflation, and as a result, it more accurately reflects the true cost of borrowing. The real rate of interest is rarely observable because most industrial economies operate with some degree of inflation, and periods of zero inflation are rare. The interest rate that we observe in the marketplace at any given time is called the nominal rate of interest. The nominal rate reflects the real rate of interest and the market’s estimate of the expected level of inflation. Inflation is the amount that aggregate price levels increase over time. Let’s now examine how the forces—the productivity of capital investments and indi- viduals’ time preference for consumption—interact to determine the real rate of interest. RETURN ON INVESTMENT Recall from your introductory finance course that businesses invest in capital projects that are expected to generate positive cash flows by producing additional real output. By more real output, we mean more automobiles, houses, high‐definition TVs, and so on.

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  Fundamentals of Corporate Finance

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

    (Publisher)

  The financial services bought or sold by financial institutions are tailor-made to fit the needs of the market they serve. Exhibit 2.4 illustrates how companies use the financial system. 9. Explain how the real rate of interest is determined in the economy, differentiate between the real rate and the nomi-nal rate of interest, and be able to compute the nominal or real rate of interest. The real rate of interest is the interest rate in the economy in the absence of inflation. It is determined by the interaction of (1) the rate of return that businesses can expect to earn on capital goods and (2) individuals’ time preference for consumption. The interest rate we observe in the marketplace is called the nominal rate of interest. The nominal rate of interest is composed of two parts: (1) the real rate of interest and (2) the expected rate of inflation. Equations 2.1 and 2.2 are used to compute the nominal (real) rate of interest when you have the real (nominal) rate and the inflation rate. Equation Description Formula 2.1 Fisher equation i = r + Δ P e + r Δ P e 2.2 Simplified Fisher equation i = r + Δ P e S U M M A R Y O F K E Y E Q U AT I O N S 2.1 Economic units that need to borrow money are said to be: (a) Lender-savers (b) Borrower-spenders (c) Balanced budget keepers (d) None of the above 2.2 Explain what marketability of a security means and how it is determined. 2.3 What are over-the-counter (OTC) markets, and how do they differ from organized exchanges? 2.4 What effect does an increase in demand for business goods and services have on the real interest rate? What other fac-tors can affect the real interest rate? 2.5 How does the business cycle affect the interest rate and inflation rate? S E L F-S T U D Y P R O B L E M S 2.1 Such units are said to be (b) borrower-spenders. 2.2 Marketability refers to the ease with which a security can be sold and converted into cash.

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  Money and Calculation

  Economic and Sociological Perspectives

  • M. Amato, L. Doria, L. Fantacci, M. Amato, L. Doria, L. Fantacci(Authors)
  • 2010(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  The points briefly outlined above will be developed in the following sections. I The rate of interest is the price of money. More precisely, it is the price paid for the use of money for a certain time. In still other terms, it is the price paid for the anticipation of a sum of money. Like all other prices, it is traditionally represented by economic theory as the point of intersection between a supply and a demand, where the demand is expressed by those who need the money to finance an economic activ- ity, and who expect to pay the interest from the proceeds of that activ- ity, and the supply is provided by those who have accumulated money, by refraining from expenditure. Like all market prices, the interest rate is assumed to settle at a level where demand equals supply, so as to clear the market. Following this line of reasoning, the classical theory described the market rate of interest as the clearing price for savings and investments. According to this theory, the rate of interest appeared as a remunera- tion for the thrift of the savers, paid by the proceeds of the activities, innovations and progress that were made possible by the anticipation of money to the investors. It was on this basis that, following Locke (1692) and Bentham (1787), the classical economists advocated a liberalization of interest on loans. This was seen as the best way to ensure an adequate incentive for the activity of saving, as a source of finance for economic growth and development. The idea, gradually disseminating common thought and practice, was eventually erected into an economic princi- ple that appeared to reconcile personal and collective interests. Saving, Calculation Implied in the Money Rate of Interest 83 no longer identified with the hideous vice of avarice, became a virtue, public and private; and interest, once banned under the infamous name of usury, became its legitimate reward.

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