Question

Please explain the determining factors of the interest rate and make sure to include hypothetical examples for better clarity.

Describe the meaning of the yield curve. Verify how the shape of the yield curve provides predictions on the economy in future years. Please visit the US Governments’ Treasury site, retrieve the data on the U.S. Treasury rates, and construct the yield curve. Indicate the date of retrieving the data.

Please explain the terms associated with the bonds, namely, corporate bond, municipal bond, treasury bill, par value, coupon rate, coupon payment, time to maturity, prevalent interest rate, market value, and yield to maturity (YTM).

Explain and provide examples of how variations in the prevalent interest rate affects the market value of a bond. Explain how you would value a stock. Provide an example of valuation of a stock based on retrieved real data. Include evidence of the retrieved data in your answer. Compare your valuation with the actual price of the stock at the designated time for your valuation.

Answer 1

Question 1)

Factors affecting the interest rates prevailing in an Economy:

1. Demand for money: Following the basic principle of economics which says that higher the demand for a commodity,

higher shall be the price of the same. The higher the demand for money in an economy, the

higher shall be the price for obtaining the funds (interest rates)

2. Supply of money: Everything else remaining constant, interest rates fall with an increase in the supply for money.

For example, post demonetization, Banks saw a huge number of currency flowing in the system, which could not be lent by them at that time. Hence, they used the funds to invest in government securities which led to a decrease in the yield on bonds (though a temporary fall).

3. Fiscal Deficit and Government Borrowing: Fiscal deficit is the excess of government expenditure over government revenues. Higher the fiscal deficit, higher the govt. borrowing (to finance the deficit) , higher the interest rates.

4. Inflation: Inflation refers to a scenario where 'too much money chases too few goods' in the economy. Thus, overall price levels increase and savers need to be compensated well for sacrificing their current consumption. Higher the inflation rates, higher will be the interest rates and vice versa.

5. Central Bank: The Central Bank can modify the monetary policy to support the economy. In recession, the Central Bank will reduce the interest rates to infuse liquidity in the Economy and encourage consumption. During boom, it will focus to contain inflation and thus increase the interest rates.