Chapter 7 - The impact of inflation and deflation, yield curves, and duration on interest rates and asset prices. After completing this unit, you should be able to learn what inflation is and how it can impact interest rates and the prices of financial assets; to understand the greater concern today over deflation and how it may affect the economy and financial system; to see how yield curves arise and explore the ideas about what determines the shape of the yield curve. | Money and Capital Markets 7 C h a p t e r Eighth Edition Financial Institutions and Instruments in a Global Marketplace Peter S. Rose McGraw Hill / Irwin Slides by Yee-Tien (Ted) Fu The Impact of Inflation & Deflation, Yield Curves, and Duration on Interest Rates and Asset Prices Learning Objectives To learn what inflation is and how it can impact interest rates and asset prices. To understand the greater concern today over deflation and how deflation may affect the economy and financial system. To see how yield curves arise and explore the ideas about what determines the shape of the yield curve at any point in time. Learning Objectives To discover how yield curves can be a useful tool for those interested in investing their money and in tracking the health of the economy. To look at the concept of duration and see how it can assist in the making of investment choices and in protecting against the risk of changing interest rates. Inflation and Interest Rates Inflation refers | Money and Capital Markets 7 C h a p t e r Eighth Edition Financial Institutions and Instruments in a Global Marketplace Peter S. Rose McGraw Hill / Irwin Slides by Yee-Tien (Ted) Fu The Impact of Inflation & Deflation, Yield Curves, and Duration on Interest Rates and Asset Prices Learning Objectives To learn what inflation is and how it can impact interest rates and asset prices. To understand the greater concern today over deflation and how deflation may affect the economy and financial system. To see how yield curves arise and explore the ideas about what determines the shape of the yield curve at any point in time. Learning Objectives To discover how yield curves can be a useful tool for those interested in investing their money and in tracking the health of the economy. To look at the concept of duration and see how it can assist in the making of investment choices and in protecting against the risk of changing interest rates. Inflation and Interest Rates Inflation refers to the rise in the average level of prices for all goods and services. 7 Inflation and Interest Rates In recent years, the . inflation and interest rates appear to be fairly strongly correlated. 1960 % % % 1970 1980 1990 2000 2001 Year Rate of Inflation (% D) CPI GDP Deflator 6-month T-bill Rate (secondary market) Inflation and Interest Rates Nominal and Real Interest Rates In general, lenders will attempt to charge nominal rates of interest that give them their desired real rates of return on their loanable funds based upon their expectations regarding inflation. nominal rate = published or quoted rate real rate = rate measured in terms of the actual purchasing power Inflation and Interest Rates The Fisher Effect In a 1896 classic article, economist Irving Fisher argued that expected nominal interest rate = expected real rate + inflation premium + (expected real rate inflation premium) expected real rate
