Financial Markets and Institutions (2-downloads)

http://www.federalreserve.gov/releases/

. Then

answer the following questions.

a. What is the difference in the interest rates on com-

mercial paper for financial firms versus nonfinan-

cial firms?

b. What was the interest rate on the one-month

Eurodollar at the end of 1971?

c. What is the most recent interest rate reported for

the 10-year Treasury note?

2. Figure 3.1 in the chapter shows the estimated real and

nominal rates for three-month Treasury bills. Go to

http://www.martincapital.com/main/charts.htm

.

Click on “Interest Rates and Yields” then on “Nominal

vs. Real Market Rates.”

a. Compare the three-month real rate to the long-

term real rate. Which is greater?

b. Compare the short-term nominal rate to the long-

term nominal rate. Which appears most volatile?

---

64

Why Do Interest Rates

Change?

Preview

In the early 1950s, nominal interest rates on three-month Treasury bills were

about 1% at an annual rate; by 1981, they had reached over 15%, then fell to

3% in 1993, rose above 5% by the mid-1990s, dropped to near 1% in 2003,

began rising again to over 5% by 2007, and then fell to zero in 2008. What

explains these substantial fluctuations in interest rates? One reason we study

financial markets and institutions is to provide some answers to this question.

In this chapter we examine why the overall level of 

nominal interest rates

(which we refer to simply as “interest rates”) changes and the factors that influ-

ence their behavior. We learned in Chapter 3 that interest rates are negatively

related to the price of bonds, so if we can explain why bond prices change, we

can also explain why interest rates fluctuate. Here we will apply supply-and-

demand analysis to examine how bond prices and interest rates change.

4

C H A P T E R

Determinants of Asset Demand

An asset is a piece of property that is a store of value. Items such as money, bonds,

stocks, art, land, houses, farm equipment, and manufacturing machinery are all

assets. Facing the question of whether to buy and hold an asset or whether to buy

one asset rather than another, an individual must consider the following factors:

1. Wealth, the total resources owned by the individual, including all assets