1. Interest Rates and Risk
Chapter 4
Interest Rates and Risk

2. 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

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

4. 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

5. 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