Corporate Finance Potential Impacts of an Increasing Research Paper

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Corporate Finance

Potential Impacts of an Increasing Interest Rates

Interest rates have a strong influence in the economy. This influence is one reason many central banks utilize interest rates as a monetary tool in an effort to control the supply of money. Since December 2008 the U.S. has seen some of the lowest central bank interest rates, with the Federal Reserve holding down rates in order to help stimulate economic growth. The Federal Reserve may have recently forecast interest rates remaining close to zero until some point in 2013, but at some point they will have to increase (Anonymous, 2011). When the interest rate rise does occur it will impact on a number of areas of the economy; this paper will consider some of those impacts.

Impact on the Financing of Big Ticket Items

Big ticket items are expensive goods which will often require the purchaser to obtain some type of credit agreement. If the interest rates increase this is likely to have a negative impact on demand for those goods, as they will become more expensive to purchase. This can be seen by looking at a simple example; a consumer is considering buying a car for $10,000 which they will finance with a 5-year loan. The impact of increasing interest rates may be seen by looking at the table below.

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Table 1; $10,000 loan over 5 years at differing interest rates

Loan at 5%

Loan at 7%

Loan at 9%

Monthly repayment

$188.61

$198.01

$207.58

Total interest

$1,322.60

$1,880.60

$2,454.80

Total repaid over term of loan

$11,322.60

$11,880.60

$12,454.80

The repayments will increase; this is likely change demand. There is a general relationship between supply and demand. As prices for goods decrease the demand usually increases (Nellis and Parker, 2006). The converse is also true; when prices increase the demand will usually decrease

(Nellis and Parker, 2006). If the purchaser is using financing the amount of the monthly loan repayment will be seen as part of the price. As seen above, if the car loan repayment increases from $188.61 to $207.58 per month this is effectively an increase of $18.97 in the monthly cost of the purchase. Where it becomes more expensive the demand for big ticket items from buyers using loans is likely to fall. They may choose alternatives such as prolonging the life of existing big ticket items, repairing rather than replacing mechanical items or extending or improving a home rather than moving (Nellis and Parker, 2006). If purchases are still made the demand may shift to the lower priced end of the market......

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