Interest Rates and their Role in Finance

These flashcards cover key concepts and definitions regarding interest rates and their role in finance, providing a comprehensive review of the lecture material.

What is the definition of an interest rate?

An interest rate denotes the percentage earnings or yield on investment; it is the cost of using money expressed as a percentage of the principal for a given period.

How are interest rates related to inflation forecasts according to the central bank of the Philippines?

Inflation is expected to remain within the target of 3.0% ±1 percentage point, influencing the central bank's decisions on interest rates.

What are the three types of money demand as defined by Laman (2023)?

1. Transaction demand, 2. Precautionary demand, 3. Speculative demand.

What is the relationship between interest rates and the demand for money?

High interest rates result in lower demand for money, while decreasing interest levels result in a higher demand for money.

What is the formula to calculate the velocity of money?

Velocity of money (V) is calculated as V = (P*Y)/M, where P is the price level, Y is real output, and M is the money supply.

Define the nominal interest rate.

The nominal interest rate is the opportunity cost of money and represents the interest rate without adjustment for inflation.

What is the purpose of a fixed interest rate?

A fixed interest rate means that the interest charged over the term of a loan will not change, providing payment stability.

What is the main distinction between nominal and real interest rates?

The real interest rate is adjusted for inflation, reflecting the true cost of borrowing or the true yield on an investment.

What role does the BSP play in determining interest rates in the Philippines?

The Bangko Sentral ng Pilipinas (BSP) decides on interest rates through the Monetary Board to promote price stability and sustainable economic growth.

List the four main roles of interest rates in the economy.

1. Promote economic growth through investment, 2. Ration available credit, 3. Balance money supply with demand, 4. Serve as a government tool for economic stabilization.

What impact do changes in interest rates have on investment and consumer spending?

Changes in interest rates directly affect the levels of investment spending and consumer expenditures in the economy.

Explain the Loanable Funds Theory concerning interest rates.

Interest rates are set by the supply and demand for all loanable funds, with higher rates encouraging more savings and lower rates boosting borrowing.

What is the impact of interest rates on bond prices?

A rise in interest rates typically results in a fall in bond prices, leading to capital losses for bondholders if they sell before maturity.

Define the term 'Yield to Maturity.'

Yield to maturity is the interest rate that equates the present value of all cash flows from a debt instrument with its current value.

What is the effect of inflation targeting on interest rates?

Inflation targeting aims to achieve low and stable inflation, which influences central bank policies, including interest rates.

How do interest rates serve as indicators of economic health?

Interest rates reflect the cost of borrowing and lending, serving as indicators of economic activity, inflation expectations, and monetary policy effectiveness.

What is the relationship between interest rates and the velocity of money?

An increase in interest rates generally leads to a decrease in the velocity of money, as people hold more cash and spend less.

Describe the difference between simple and compound interest.

Simple interest is calculated only on the original principal, while compound interest is calculated on the principal and accumulated interest.