Ba 580 interest rates
Download
1 / 12

BA 580-Interest Rates - PowerPoint PPT Presentation


  • 111 Views
  • Uploaded on

BA 580-Interest Rates. Breaking Down Market Influences on Rates. Influences on Rates. Factors that influence all rates as well as account for differences in rates Inflation Market forces on supply and demand for loans (price of borrowing-lending)

loader
I am the owner, or an agent authorized to act on behalf of the owner, of the copyrighted work described.
capcha
Download Presentation

PowerPoint Slideshow about 'BA 580-Interest Rates' - shelagh


An Image/Link below is provided (as is) to download presentation

Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author.While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server.


- - - - - - - - - - - - - - - - - - - - - - - - - - E N D - - - - - - - - - - - - - - - - - - - - - - - - - -
Presentation Transcript
Ba 580 interest rates l.jpg

BA 580-Interest Rates

Breaking Down Market Influences on Rates


Influences on rates l.jpg
Influences on Rates

  • Factors that influence all rates as well as account for differences in rates

    • Inflation

    • Market forces on supply and demand for loans (price of borrowing-lending)

      • Income growth & expectations (consumption; business investment decisions)

      • Risk

      • Time


Inflation rates why connected l.jpg
Inflation & Rates: Why Connected?

  • Inflation = change in purchasing power of $

    • With 5% inflation for 1 year, lender receives dollars worth $9500 on a 1-year $10,000 note

  • Nominal rates made up of price for borrowing (real rate) plus premium for expected inflation

    • R = r + Pe

    • Implies 1:1 relationship between R and Pe

    • “Money Center” banks estimate Pe

    • Bond buyers/sellers incorporate formal & informal

    • Estimates by surveys of experts, guesses based on recent history, or stat models e.g.

      • PI = 1 + 0.4*infl(-1 month) + 0.2*(-2 months) + 0.15*(-3 months)


Evidence on inflation rates l.jpg
Evidence on Inflation & Rates

  • Regression Evidence

    R-Square indicates the % of the changes in the given rate that can be attributed to predicted inflation

    Slope indicates whether the relationship is 1:1 – e.g.

    0.95 means that the T-bill rate goes up about .95% for each 1% increase in predicted inflation


Differences in rates due to inflation l.jpg
Differences in Rates Due to Inflation

  • Predicted inflation more closely related to and closer to 1:1 for short term rates


Market influences on real rates economy wide level l.jpg
Market Influences on Real Rates(Economy-Wide Level)

  • Analytics: risk; income growth; time

    • Income growth influences demand & supply

    • Timing of income growth influence a key

    • Measuring economy wide risk

      • Bbb Rate – Aaa Rate


Real rate movements l.jpg
Real Rate Movements

  • Real 10-year T-Bond Rate Movements

    • Monthly data 1960-2004

      TB10 Rate = 0.03* above avg. (3.1%) growth

      + 0.5*(Bbb – Aaa rate)

      Implies 1% additional growth raises TB10 by 3 basis pts

      Implies 1% additional risk premium raises TB10 by 5 basis pts


Market influences on real rates individual business loan level l.jpg
Market Influences on Real Rates(Individual Business Loan Level)

  • Analytics: income potential (profitability) and risk measures

    • Profitability (Past-expected Return on Assets)

    • Risk

      • Default-Credit (Debt/Equity, …)

      • Liquidity (ST assets/ST liabilities, …)

      • Term (length of loan)

  • Methods

    • Simple: use thresholds

    • Complex: use “scoring” or “likelihood” producing statistical methods such as regression, discriminant analysis, …


Why rates differ l.jpg
Why Rates Differ

  • Law of One Price

    • Resale not limited by law or product

    • Price Market A = Price Market B + cost difference

    • Implies demand differences are not sufficient to sustain price differences; cost difference (transport; storage; … and risk)

  • SF Fed Article link explains non-risk cost differentials

  • Loans of similar nature (risk) and time are very, very closely related (see irates.xls)

  • Because Time (term of loan) is closely intertwined with risk, it is a key reason that rates differ


Time rate differences l.jpg
Time & Rate Differences

  • R(short) = R(long) + cost differences

  • What costs/risks differ or may differ depending on length of the loan?

    • Inflation

    • Income growth

  • Yield Curve – graph of rates over time

    • Typically graphing loans that are similar except with regard to length such as Treasury Yield Curve, Corporate Aaa Yield Curve, …

  • Yield Curve Shape Changes with changes in views about future inflation & income growth


Digging into the yield curve l.jpg
Digging Into the Yield Curve

  • “Normal” Yield Curve – about a 2% difference in 3-month & 10-year T-rates

  • Higher Inflation Expected Near Term?

    • Flatter or even negative Yield Curve

  • Lower Income growth expected near term?

    • Flatter or even negative Yield curve

  • See website links (Living Yield Curve; NY Fed for examples and current situation)


Digging into yield curve con t l.jpg
Digging into Yield Curve (con’t)

  • Difficulties in Interpreting Yield Curve

    • Separating Inflation from other Influences

    • Expectations are not always correct

  • Inflation-Indexed Treasury Securities (TIPS) as way to separate out inflation part of Yield Curve

    • See forwardyields.xls for example