Managing Capital Markets and finance/ Calculation - Essay Example

Then at the end of year lender will be paid back $ 108 but due to inflation these $ 108 would actually value at about $ 96. Hence the lender would actually be paying $ 4 to borrower for using his money. To avoid the situation nominal interest rates are charged to compensate for the inflation that exists in the economy. And as the inflation rates are high, the nominal rates also go high (McConnell C. & Brue S., 2002). 4. If there is an expectation of lower interest rates and the bonds are offering coupon rates higher than the expected future interest rates then the bond prices will rise since more and more people will try to invest in bonds due to higher coupon payments associated with them.

Since the yield curve shows the relation between the yield and the maturity of securities. With the expectation of lower interest rates in the future, the yield to short term maturities will be high as compared to the long term maturities and it will take the shape of an inverted yield curve. 5. An investor investing his money in the bonds with longer maturity is actually taking a risk in this investment due to the volatile nature of the interest rates. Such an investor is required a premium for this risk and ask for a compensation.

This risk premium gives the yield curve an upward bias. For such reasons, the coupon rates for short term bonds are less than that for long term bonds. 6. When the fed decides to increase the money supply in the market, it starts buying back the securities from the banks which results in the injection of money in the market. Federation buys back the securities from two sources. One can be commercial banks and other can be general public. When the fed buys the securities from a commercial bank it increases its own assets by securities and raises the commercial bank’s reserves to complete the transaction.

This increase in