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Economics: Interest Rates

Economics: Interest Rates. AP Economics Period 0. Vanessa Martinez Winnie Reece. Interest Rates. An Interest Rate is the price a borrower pays for the use of money one does not own. [usually expressed as a percentage rate over the period of a year]

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Economics: Interest Rates

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  1. Economics: Interest Rates AP Economics Period 0 Vanessa Martinez Winnie Reece

  2. Interest Rates • An Interest Rate is the price a borrower pays for the use of money one does not own. [usually expressed as a percentage rate over the period of a year] • Interest Rates targets are also a vital tool of the monetary policy, and are used to control variables like investment inflation and unemployment • A Nominal Interest Rate is the amount of payable interest • For example, suppose a household deposits $100 with a bank for 1 year and they receive interest of $10. At the end of the year their balance is $110. In this case, the nominal interest rate is 10% per annum. • A Real Interest Rate measures the purchasing power of interest receipts Is calculated by adjusting nominal interest rates charged to take inflation into account. For Example If inflation in the economy has been 10% in the year, then the $110 in the account at the end of the year buys the same amount as the $100 did a year ago. The real interest rate, in this case, is zero.

  3. Calculating Real vs Nominal Interest Rate • Ir = In – p P is the overall inflation rate of that year. • Ir = In – pe Expected real returns on an investment before being made. In = Nominal Interest Rate Ir = Real Interest Rate Pe= Projected or expected rate all year.

  4. Market Operations in the U.S • Using the power to buy and sell treasury securities, the Open Market Desk at the Federal Reserve Bank of New York can supply the market with dollars by purchasing T-notes, increasing the nation's money supply. By increasing the money supply or Aggregate Supply of Funding (ASF), interest rates will fall due to the excess of dollars banks will end up with in their reserves.

  5. Federal Funds Rate • The federal funds rate is the interest rate at which private depository institutions (mostly banks) lend balances (federal funds) at the Federal Reserve to other depository institutions, usually overnight. Changing the target rate is one form of open market operations that the Chairman of the Federal Reserve uses to regulate the supply of money in the U.S. economy.

  6. Mortgage Interest Rate • that limit the amount the interest rate on an ARM loan can change in an adjustment interval and/or over the life of the loan. For example, if your per-period cap is 1% and your current rate is 7%, then your newly adjusted rate must fall between 6% and 8% regardless of actual changes in the index

  7. Sources • Mortgage101 http://www.mortgage101.com/Rates/Index.asp?p=mtg101 • Wikipedia http://en.wikipedia.org/wiki/Interest • Quicken loans https://www.quickenloans.com/mortgage-glossary/interest-rate-cap?qls=MLP_Refernce.MtgGls0155

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