Questions and Answers
What sector is primarily considered the largest supplier of loanable funds?
Which of the following is true regarding government demand for loanable funds?
What triggers businesses to demand loanable funds?
What does the Expectations Theory attempt to predict?
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Under which condition do government units act as suppliers of loanable funds?
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What is the primary purpose of issuing municipal bonds by local governments?
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What does the Pure Expectations Theory state about the yield curve?
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What role do businesses with cash inflows exceeding outflows play in the loanable funds market?
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What happens to the demand curve of the treasury bond when demand increases?
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What is the relationship between the price of a bond and the interest rate when demand increases?
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Which of the following correctly describes a risk-free rate?
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Which corporation is responsible for trading services in the Philippine Dealing System?
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According to Irving Fisher's theory, what do nominal interest payments compensate for?
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What does the Fisher Effect explain?
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What role does the Philippine Securities Settlement Corp. (PSSC) play in the PDS Group?
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What is a characteristic of Treasury Bills in relation to default risk?
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What is a swap rate primarily used for in interest rate swaps?
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Which of the following best describes the floating interest rate in swaps?
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What does a higher credit rating signify for a country or company?
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Which rating agency gathers data from 128 countries using 1,500 credit analysts?
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What defines an AAA rating assigned by S&P Global Ratings?
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Which aspect significantly influences credit ratings according to the content?
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What could happen to Ocampo Company if LIBOR exceeds its servicing capability of 7%?
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Which of the following categories does not exist in S&P's credit ratings?
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What is the primary purpose of the spot rate?
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Which scenario illustrates the use of a forward rate?
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What happens to the spot rates when external forces like natural disasters occur?
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What is a potential risk for Ocampo Company concerning its forward rate contract?
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In the context of the content, what does the term 'historical yield' refer to?
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What is a likely outcome for Ocampo Company if the market rate remains at 6% after the tenth year?
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What does the forward rate guarantee for the transaction being negotiated?
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Which statement best captures the impact of commodity prices on spot rates?
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What is the rating assigned when a default is expected to be a virtual certainty?
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Which rating represents obligations of the highest quality with minimal credit risk?
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What does a B rating indicate about an obligation?
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What is the meaning of a Caa rating?
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When are payments not made on an obligation, according to the rating definition?
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What characteristic is associated with obligations rated Baa?
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Which rating designation represents an obligation that is judged to have speculative elements?
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What does the term 'default' refer to in the context of these ratings?
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Study Notes
Loanable Funds Supply and Demand
- Household sector supplies the most loanable funds through savings.
- Businesses seek loanable funds for investments in both long-term and short-term assets, influenced by the number of projects planned.
- Successful businesses with excess cash flows can also supply loanable funds.
- Government demand for loanable funds arises when expenditures exceed tax revenues, typically issuing municipal bonds, Treasury, and agency securities.
- Government demand for funds is seen as interest-inelastic, meaning it does not heavily depend on interest rates.
- When governments run surpluses, they lend excess revenues to businesses and households, exemplified by DTI’s 1 billion pesos loan for MSMEs.
Expectations Theory
- This theory posits that interest rates are influenced by lenders' and borrowers' expectations of future market risks.
- Predicts short-term interest rates based on current long-term rates.
- Pure Expectations Theory: Suggests that the yield curve reflects expectations of future interest rates; when treasury bond demand increases, bond prices rise, consequently raising interest rates.
Risk-Free Rate and Government Securities
- The risk-free rate indicates zero default risk, typically aligned with government bond rates like Treasury Bills, which are fully backed by the government.
- In the Philippines, risk-free rates can be derived from the Philippine Dealing System (PDS) Group, which comprises four corporations focused on trading, settlement, training, and security services.
Nominal and Real Interest Rates
- Fisher’s theory explains that nominal interest compensates savers for lost purchasing power and for foregoing present consumption.
- The Fisher Effect describes how inflation impacts interest rates, indicating that savers need a premium over expected inflation for deferring consumption.
- Specific interest rate forecasts require precise data beyond what the yield curve provides.
Spot, Forward, and Swap Rates
- Spot Rate: The current interest rate available, used for immediate transactions, influenced by historical yields and market conditions.
- Forward Rate: Agreed upon today for a transaction in the future; it serves as a financial tool to manage risk over time.
- Swap Rate: Involves exchanging fixed interest rates for floating rates, used to mitigate the uncertainty of rate fluctuations in financial agreements.
Credit Ratings
- Credit ratings assess the risk associated with countries and corporations, influencing interest rates.
- A higher credit rating indicates lower default risk, essential for investors.
- Major credit rating agencies include:
- Standard and Poor’s Corporation (S&P): Categorizes credit ratings from AAA (highest quality) to D (in default).
- Moody’s Investors Service: Ranges from Aaa (minimal credit risk) to Caa (very high credit risk).
Rating Categories Defined
-
S&P Ratings:
- AAA: Extremely strong capacity to meet financial commitments.
- AA: Very strong, likely to default due to high certainty.
- C: Highly vulnerable to nonpayment.
- D: Currently in default.
-
Moody's Ratings:
- Aaa: Highest quality, minimal credit risk.
- Aa: High quality, very low credit risk.
- B: Speculative, high credit risk.
- Caa: Poor standing, very high credit risk.
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Description
This quiz explores the concepts surrounding loanable funds, focusing on the household sector as a primary supplier and the demand from businesses and government. Understand the dynamics of saving and investment for short-term and long-term assets. Test your knowledge on how these elements interact within the economy.
