CH 9: Interest Rates

Prime rate

Basic interest on short-term loans that the largest commercial banks charge to their most creditworthy customers.

Commercial paper

Short-term, unsecured debt issued by the largest corporations

CDs

The interest rate on certificates of deposit. Large denomination deposits of $100,000 or more at commercial banks.

Bankers acceptance

A postdated check on which a bank has guaranteed payment. Commonly used to finance international trade transactions.

Treasury bills

Short-term government debt issued that represent risk-free rate.

a pure discount security

interest bearing asset

Sold at a discount

makes a single payment of FV at maturity

Makes no payments before maturity

The bank discount basis

a method for quoting interest rates on money market instruments, such as bankers acceptances.

Nominal interest rates

interest rates as they are observed and quoted, with no adjustment for inflation.

Real interest rates

adjusted for inflation effects

The Fisher Hypothesis

Asserts that the general level of nominal interest rates follows the general level of inflation. Interest rates are, on average, higher than the rate of inflation.

Expectation Theory

the term structure of interest rates reflects financial market beliefs about future interest rates. Closely related to the Fisher hypothesis in that if expected future inflation is higher than current inflation, then it will be an upward-sloping term structure. and vice-versa.

Maturity Preference theory

Long-term interest rates contain a maturity premium necessary to induce lenders into making longer term loans. Borrowers have to pay higher rates to borrow longer term.

Market Segmentation theory

Debt markets are segmented by maturity, so interest rates for various maturities are determined separately in each segment. Interest rates corresponding to each maturity are determined by supply and demand conditions in each segment.