Interest Rates and Risk Chapter 4 Interest Rates and Risk

Learning Objectives 4-1 Describe how interest rates are determined in the financial markets Describe or explain the concept of risk Name the types of risk associated with the different types of financial instruments Explain why investors in securities require a higher rate of return when different elements of risk are associated with different securities

Interest Rates Rate of return or yield 4-2 Interest Rates Rate of return or yield Auction process for Treasury obligations

RISK Inflation or Purchasing Power Risk Default Risk Maturity Risk 4-3 Inflation or Purchasing Power Risk Default Risk Maturity Risk Callability Risk Liquidity Risk

The Federal Reserve System and Interest Rates 4-4 The Federal Reserve System and Interest Rates The U.S. bonding system “creates” most of the money supply Demand deposits represent about 80%-85% of money supply Federal Reserve System created in 1913 to regulate commercial bonds Controls the money supply by setting a reserve ratio and controlling the volume of reserves