ADMN 4720 Chapter 2

Nominal Interest Rates

The interest rates actually observed in financial markets.

Loanable Funds Theory

Explains interest rates and their movements based on the supply and demand of loanable funds.

Supply of Loanable Funds

Describes funds provided to financial markets by net suppliers of funds.

Demand for Loanable Funds

Describes the total net demand for funds by fund users.

Default Risk

The risk that a security issuer will fail to make promised interest and principal payments.

Liquidity Risk

The risk that a security can be sold at a predictable price with low transaction costs on short notice.

Real Risk-Free Rate

The interest rate that would exist on a risk-free security if no inflation were expected.

Inflation Rate

The continual increase in the price level of a basket of goods and services.

Credit Risk Premium (CRP)

The difference between a quoted interest rate on a security and a Treasury security with similar features.

Fisher Effect

The relationship among the real risk-free rate, expected rate of inflation, and nominal interest rate.

Time Value of Money

The concept that a dollar received today is worth more than a dollar received at some future date.

Future Value (FV)

The amount of money that an investment will grow to over a period of time at a given interest rate.

Present Value (PV)

The current worth of a cash flow that will be received in the future, discounted back at an interest rate.

Annuity

A series of equal cash flows received at regular intervals over time.

Equilibrium Interest Rate

The interest rate that balances the supply and demand for loanable funds.

Market Segmentation Theory

The idea that interest rates are determined by distinct supply and demand conditions within different maturity segments.