How Supply and Demand Impacts Interest Rates Research Paper

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Who are the suppliers of loanable funds?To begin, the loanable funds market represents that aggregate savers and the aggregate borrowers within a particular economy. In regards to the capital markets, the providers of capital can come from a multitude of sources. These suppliers of loanable funds are looking to defer current consumption in exchanges for an adequate rate of return in the future. This rate of return is primarily dependent on the prevailing interest rates at the time. Likewise, those looking to utilize borrower’s funds must also entice the suppliers of loanable funds with an appropriate rate of return. It is the nature of capital markets to match these suppliers of loanable funds with those looking to use their funds in exchange for an adequate rate of return. The suppliers of loanable funds are typically households, financial intermediaries, banks, foreign investors, governments, and even individuals using peer to peer lending.Households supply funds through their ability to generate cash flow in excess of their immediate needs. This excess cash flow is typically allocated into a various investment vehicles including certificates of deposits, savings account, checking accounts, IRA’s and more. In certain instances, individuals can supply loanable funds to investors directly through peer to peer lending. Here, terms and conditions are met on an individual basis. As such, these loans are much riskier as underwriting standards can vary by the individual supplying the capital. In addition, default risk is much higher as many individual providers of loans are not diversified enough to counter a long and protracted market decline. In exchange for this many individual suppliers of capital may often demand higher interest rates or fees.Governments often generate income through taxes or by providing bonds to the capital markets. Higher providers of loanable funds provide governments with capital in exchange for their promise to pay these bonds later. This municipal bonds as they are called are often much more attractive to high net worth individuals as they have tax advantages that other bonds may not have. They also have a much higher perceived quality as they are backed by the government’s ability to level taxes on the state and local level. This tax ability allows governments to exert a large influence on the markets through their ability to appropriately tax. Governments tend to generate excess cash through proper budgeting as revenues are in excess of expenditures. These excess funds can then be used to invest in other assets classesPensions and other institutions provide loanable funds to the market as well. Pensions are particularly powerful as the often represent large constituencies in the market. They typically take a portion of the funds generated in the labor market and use they to invest on behalf of large employee constituencies. Pension funds have strict mandates by which to invest.

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Many can only invest in very high quality assets such as AAA rated securities or equity that is included in a particular market index. Due to these restrictions, the investment universe of pensions and other institutions can be limited. However, due to their size these institutions can provide large pools of capital where other market participants cannot.Foreign investors tend to provide loan funds when interest rates higher in the United States as oppose to their home country. Here these foreign investors look for markets that are liquid, efficient, and well run. Currently, Asian foreign investors have…

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…to a government for 10 years at just 2%. They instead will demand investments that are more speculative or provide their loanable funds to their companies or projects.What are the six factors that determine the nominal interest rate on a security?The six factor that determine nominal interest rates are as follow:1. Quantity - loans are being “bought” and “sold” in this market. The “quantity” in this market is really the quantity of loans or, more formally, the quantity of loanable funds. The velocity of money flowing within the market can influence inflation expectations, which ultimately affects interest rates on a go forward basis. This impact on interest rates, will then affect the demand for loans as companies anticipate higher interest rates in the future.2. Price - the cost of borrowing is the real interest rate, and the reward for savings is the real interest rate. As noted in point one, low interest rates along with inflation expectations affect interest rates.3. Supply - The supply of loanable funds represents the behavior of all of the savers in an economy. The higher interest rate that a saver can earn, the more likely they are to save money. As such, the supply of loanable funds shows that the quantity of savings available will increase as the interest rate increases.4. Demand - The demand for loanable funds represents the behavior of borrowers and the quantity of loans demanded. The lower the interest rate, the less expensive it is to borrow.5. Equilibrium - The equilibrium in the market for loanable funds is achieved when the quantities of loans that borrowers want are the same as the quantity of savings that savers provide. The interest rate adjusts to….....

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