Introduction to Finance

LEARNING ACTIVITY
Go to the website of the Board of Governors of the Federal Reserve System, http://www.
federal reserve.gov. Find current interest rates for diff erent maturities of U.S. Treasury 
securities, and construct the current yield curve.
liquidity preference theory 
states 
that investors are willing to accept 
lower interest rates on short-term 
debt securities that provide greater 
liquidity and less interest rate risk
market segmentation theory 
states that interest rates may diff er 
because securities of diff erent 
maturities are not perfect substitutes 
for each other

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8.5 Inflation Premiums and Price Movements
207
8.5
Inflation Premiums and Price 
Movements
Actions or factors that change the value of the money unit or the supply of money and credit 
aff ect the whole economy. The change aff ects, fi rst, the supply of loanable funds and interest 
rates and, later, both the demand for and the supply of goods in general. 
Infl ation
, as previ-
ously defi ned, is an increase in the price of goods or services that is not off set by an increase 
in quality. Recall that when investors expect higher infl ation rates, they will require higher 
market interest rates so that a real rate of return will remain after the infl ation. A clearer under-
standing of investor expectations about infl ation premiums can be had by fi rst reviewing past 
price movements, and then exploring possible types of infl ation.
Historical International Price Movements
GLOBAL
Changes in the money supply or in the amount of metal in the money unit have infl u-
enced prices since the earliest records of civilization. The money standard in ancient Babylon 
was in terms of silver and barley. The earliest available price records show that one shekel 
of silver was equal to 240 measures of grain. At the time of Hammurabi (about 1750 
B
.
C
.), 
a shekel in silver was worth between 150 and 180 measures of grain, while in the following 
century it declined to 90 measures. After Persia conquered Babylonia in 539 
B
.
C
., the value of 
the silver shekel was recorded as between 15 and 40 measures of grain.
Alexander the Great probably caused the greatest infl ationary period in ancient history 
when he captured the large gold hoards of Persia and took them to Greece. Infl ation was high 
for some years, but 20 years after Alexander’s death, a period of defl ation began that lasted 
for over 50 years.
The fi rst recorded cases of deliberate currency debasement (lowering the value) occurred 
in the Greek city-states. The government would debase currency by calling in all coins and 
issuing new ones containing less of the precious metals. This must have been a convenient 
form of infl ation, for there are many such cases in the records of Greek city-states.