FINANCIAL MARKET

MODULE

Prepared by:

MS. SHEILA MAY A. FIEL

Instructor
 Dear Student,
Panagdait sa Tanang
Kabuhatan!
The success of this
module lies in your hands.
This was prepared for you
to learn diligently,
intelligently, and
independently. This will be
a great opportunity for you
to equip yourself not only
with academic content but
as well as some invaluable
skills which you will be very
proud of as a responsible
learner.
 STUDY SCHEDULE AND HOUSE RULES

Course Title: Financial Market

Course Description: Financial markets, or markets for financial assets, play an

important role in the efficient functioning of a market economy. Financial Institutions
are any establishments that make these markets function efficiently. The course
studies the fundamental principles that govern financial markets and institutions. We
attempt to understand the workings of the Banking Industry, the Federal Reserve and
the behaviour of financial intermediaries.

This course explores the function, pricing, and institutional structures of financial
markets. Our intent is to understand the differences between these instruments and
the institutions that operate in today's financial markets. Rapid changes in the
composition of financial instruments and institutions mean that the content of this
course must be evolving as well. Understanding the economic foundations of these
intermediaries, in addition to the institutional instruments, and developing your
analytical and research skills, will prepare you not only for today's job market, but will
also help to increase your educational flexibility in adapting to future changes.

Topics also include valuation of financial assets and the characteristics of

financial instruments in money and capital markets. We analyze the relationships
among financial institutions, monetary policy and the stability of the economy as a
whole.

STUDY SCHEDULE
MODULE 1:
• Overview of Financial Environment
At the end of the module you will be able to:
1. Define what is financial market;
2. Describe the types of financial markets;
3. Describe the types of securities traded within financial markets;
4. Describe the role of financial institutions within financial markets;
5. Explain how financial institutions were exposed to the credit crisis;
6. Apply the loanable fund theory to explain why interest rates change;
7. Identify the most relevant factors that affect interest rate movements;
8. Explain how to forecast interest rates;
9. Describe how characteristics of debt securities cause their yields to vary;
10. Explain the theories behind the term structure of interest rates.

WEEK TOPIC Date Time

Lesson 1 – The Role of Financial 08/10/2020 8:30 – 10:00 am
Week 1-2
Markets and Institutions 08/27/2020 8:30 – 10:00 am
09/03/2020 8:30 – 10:00 am
Week 3-4 Lesson 2 – Interest Rate Determination 09/03/2020 8:30 – 10:00 am
09/10/2020 8:30 – 10:00 am
 09/14/2020 8:30 – 10:00 am
09/17/2020 8:30 – 10:00 am
PRELIM EXAMINATION

The following guides and house rules will help you to be on track and complete the
module with a smile on your face.
1. Read and understand every part of the module. If there are some contents or tasks
which you find difficult to understand, try to re-read and focus. You may also ask help
from your family at home, if it doesn’t work, you may send a private message on my
Facebook account (Sheila May Albaracin Fiel) or you may text me on this cellphone
number 09387329442.
2. Each module begins with an overview and a list of the topics you are expected to learn.
3. Before reading the module and working on the activities, answer the pretest first. Find
out how well you did by checking your answers against the correct answers in the
answer key.
4. At the end of each lesson try to reflect and assess if you were able to achieve the
learning objectives. Remember that you can always read again if necessary.
5. Learn to manage your time properly. Study how you can manage to work on this module
in consideration of your other modules.
6. Each module has worksheets where you can do all your activities. At the end of the
month, remove the worksheets and submit them to your teacher.
7. Have patience and do not procrastinate.
8. Practice the virtue of honesty in doing all your tasks.
9. Lastly, the activities in the module must be done by you and not by others. Your family
and friends may support and guide you but you must not let them do the work. DO
YOUR BEST AND GOD WILL DO THE REST.

Ms. Sheila May A. Fiel

Instructor
 Module 1

OVERVIEW OF THE FINANCIAL

ENVIRONMENT
 MODULE CONTENTS
I. Introduction: What is this Module About?
II. Lesson 1: The types of Financial Markets and Institutions
III. Lesson 2: Interest Rate and Determination
IV. References
 Modue 1 Overview of the Financial Market

What is this Module about?

Reflect on the quote above. Is it not amazing what education can do? How it transforms
an individual and changes one’s life? Did you ever wonder how teachers teach and affect
students? How they carefully plan everything? You’d be surprised to know that teachers and
experts spend a great deal of thought, time, effort and expertise to help a learner develop his
potential to the fullest.

It's the teacher’s responsibility to guide the learners towards becoming the best that they
can be. They are tasked to help provide students with the knowledge, skills, attitudes, and
values they need to succeed in their studies, work and life.

As a future accountants, you too have the responsibility to prepare yourself to become
an important agent who possesses knowledge and understanding of how you can help our
economy. This module will help you take the first step in achieving the goals stated above.

Lesson 1: The Role of Financial Markets and Institutions

Lesson 2: Interest Rate Determination

So are you now ready to embark on this journey? I wish you an enriching and productive
learning experience.
 Module 1
Lesson 1 What is Financial Market?

Introduction

A STRONG FINANCIAL SYSTEM IS NECESSARY FOR A GROWING AND PROSPEROUS

ECONOMY

Financial managers and investors don’t operate in a vacuum—they make

decisions within a large and complex financial environment. This environment includes financial
markets and institutions, tax and regulatory policies, and the state of the economy. The
environment both determines the available financial alternatives and affects the outcomes of
various decisions. Thus, it is crucial that investors and financial managers have a good
understanding of the environment in which they operate.
History shows that a strong financial system is a necessary ingredient for a
growing and prosperous economy. Companies raising capital to finance capital expenditures as
well as investors saving to accumulate funds for future use require well-functioning financial
markets and institutions.

Learning Outcomes:

At the end of the lesson you will be able to:

✓ Define financial market;
✓ Describe the types of financial markets;
✓ Describe the role of financial institutions within financial markets.

Figure 1. ETL and DI in Data Science: usage in financial market data warehouses.
Retrieved from: https://towardsdatascience.com/etl-and-di-in-data-science-usage-in-financial-markets-data-warehouses-21df4e1ebb42
Take Off

Have you heard the word Financial Market before? What do you think is Financial
Market? What is its role to the business sectors? Kindly take a few minutes to ponder about
these questions before proceeding.

Content Focus

A financial market is a market in which financial assets (securities) such as stocks and bonds
can be purchased or sold. Funds are transferred in financial markets when one party purchases
financial assets previously held by another party. Financial markets facilitate the flow of funds
and thereby allow financing and investing by households and firms, and government agencies.

ROLE OF FINANCIAL MARKETS

Financial markets play a vital role in the allocation of resources and operation of
modern economies. Financial markets create products that provide a return for those who have
excess funds (Investors/lenders), making these funds available to those who need additional
money (borrowers). They provide a market that bridges the gap between borrowers and
lenders.

Financial markets transfer funds from those who have excess funds to those who
need funds. For example, they enable college students to obtain student loans, families to
obtain mortgages, business to finance their growth, and governments to finance many of their
expenditures. Many households and businesses with excess funds are willing to supply funds to
financial markets because they earn a return on their investment. If funds were not supplied, the
financial markets would not be able to transfer funds to those who need them.

Those participants that have greater income than their expenditures are referred
to as surplus units (investors). However, those participants that have greater expenditures
than their income are referred to as deficit units (borrowers).

The surplus units provide their net earnings to the financial market to earn return
on investment while the deficit units access funds to the financial markets so they can spend
more money than they receive.

Example_____________________________________________________________________

College students are typically deficit units, as they often borrow from financial
markets to support their education. After they obtain their degree, they earn more income than
they spend and thus become surplus units by investing their excess funds. A few years later,
they may become deficit units again by purchasing a home. At this stage, they may provide
funds to and access funds from financial markets simultaneously. That is, they may periodically
deposit savings in a financial institution while also borrowing a large amount of money from a
financial institution to buy a home.

1. Accommodating Corporate Finance Needs

A key role of financial markets is to accommodate corporate finance activity.
Corporate finance (also called financial management) involves corporate
decisions such as how much funding to obtain what and what types of
securities to issue when financing operations. The financial markets serves
as the mechanism whereby corporations (acting as deficit units) can obtain
funds from investors (acting as surplus units).

2. Accommodating Investment Needs

 Another key role of financial markets is accommodating surplus units who
want to invest in either debt or equity securities. Investment management
involves decisions by investors regarding how to invest their funds. The
financial markets offer investors access to a wide variety investment
opportunities including securities issued by the Treasury and government
agencies as well as securities issued by corporations.

Primary versus Secondary Markets

Primary markets facilitate the issuance of new securities. Secondary

markets facilitate the trading of existing securities, which allows for a change in
the ownership of the securities. Primary market transactions provide funds to the
initial issuer of securities; secondary market transactions do not.
An important characteristic of securities that are traded in secondary
markets is liquidity, which is the degree to which securities can easily be
liquidated (sold) without a loss of value. Some securities have an active
secondary market, meaning that there are many willing buyers and sellers of the
security at a given moment in time. Investors preferred liquid securities so that
they can easily sell the securities whenever they want (without a loss in value). If
a security is illiquid, investors may not be able to find a willing buyer for it in the
secondary market and may have to sell the security at a large discount just to
attract a buyer.

Example_____________________________________________________________________

Last year, Riverto Co . had excess funds invested in newly issued Treasury debt
secuirties with a 10-year maturity. This year, it will P15 million to expand its operations. The
company decided to sell its holdings of Treasury bonds in the secondary market and received
P5 million from the sale. In also issued in its own debt securities, which have a 10-year maturity,
in the primary market. The investors who purchased Riverto’s debt securities can redeem them
at maturity or sell them before that time to other investors in the secondary market.

SECURITIES TRADED IN FINANCIAL MARKETS

Securities can be classified as money market securities, capital market securities, or derivative
securities.

1. Money Market Securities

Money markets facilitate the sale of short-term debt securities by deficit units to surplus
units. The securities traded in this market are refers to as money market securities,
which are debt securities that have a maturity of one year or less. These generally have
a relatively high degree of liquidity, not only because of their short term maturity but also
because they commonly have an active secondary market. Money market securities
tend to have a low expected return but also a low degree of risk. Common types of
money market securities include Treasury bills (issued by the government through the
Bureau of Treasury), commercial paper (issued by corporations) and negotiable
certificates of deposit issued (issued by depository institutions).

2. Capital Market Securities

Capital markets facilitate the sale of long-term securities by deficit units to surplus units.
The securities traded in this market are referred to as capital market securities. Capital
market securities are commonly issued to finance the purchase of capital assets, such
as buildings, equipment, or machinery.

Three common types of capital market securities:

 • Bonds- are long term debt securities issued by the treasury, government
agencies and corporations to finance their operations. They provide a return to
investors in the form of interest income every six months. Since bonds represent
debt, they specify the amount and timing of interest and principal payments to
investors who purchase them. At maturity, investors holding the debt securities
are paid the principal. Bonds commonly have maturities of between 10 and 20
years.

• Mortgages- are long-term debt obligations created to finance the purchase of

real state. Lenders assess the likelihood of loan repayment by using various
criteria such as the borrower’s income level relative to the value of the home.
They offer prime mortgages to borrowers who qualify based on these criteria.

• Mortgage-Backed Securities- are debt obligations representing claims on

package of mortgages. There are many form of mortgage-backed securities. In
their simplest form, the investors who purchase these securities receive monthly
payments that are made by the homeowners on the mortgages backing the
securities.

• Stocks- (or equity securities) represent partial ownership in the corporations that
issued them. They are classified as capital market securities because they have
no maturity and therefore serve as a long-term source of funds. Some
corporations provide income to their stockholders by distributing a portion of their
quarterly earnings in the form of dividends. Other corporations retain and reinvest
all their earnings which increases their growth potential.

3. Derivative Securities
Derivative securities are financial contracts whose values are derived from the values
underlying assets such as debt securities or equity securities. Many derivative securities
enable investors to engage in speculation and risk management.

Speculation Derivative securities allow an investor to speculate on movements in the

value of underlying assets without having to purchase those assets. Some derivative
securities allow investors to benefit from an increase in the value of underlying assets,
whereas others allow investors to benefit from a decrease in the assets’ value. Investors
who speculate in derivative contracts can achieve higher returns than if they had
speculated in the underlying assets, but they are also exposed to higher risk.

Risk Management Derivative securities can be used in a manner that will generate
gain if the value of underlying assets declines. Consequently, financial institutions and
other firms can use derivative securities to adjust the risk of their existing investments in
securities. If a firm maintains investments in bonds, it can take specific positions in
derivative securities that will generate gains if bond values will decline. In this way
derivative values can be used to reduce a firm’s risk. The loss of the bonds is offset by
the gains on these derivative securities.

ROLE OF FINANCIAL INSTITUTIONS

Because financial markets are imperfect, securities buyers and sellers do not have full access
to information. Individuals with available funds are not normally capable of identifying
creditworthy borrowers to whom they could lend those funds. In addition, they do not have the
expertise to assess the creditworthiness of potential borrowers. Financial institutions are needed
to resolve the limitations caused by market imperfections. They accept funds from surplus units
and channel the funds to deficit units. Without financial institutions, the information and
transaction costs of financial market transactions would be excessive. Financial institutions can
be classified as depository and non-depository institutions.

Role of Depository Institutions

Depository institutions accepts deposits from surplus units and provide credit to deficit units
through loans and purchases of securities. They are popular financial institutions for the
following reasons.

• They offer deposit accounts that can accommodate the amount and liquidity
characteristics desired by most surplus units.
• They repackage funds received from deposits to provide loans of the size and maturity
desired by deficit units.
• They accept the risk on loans provided.
• They have more expertise than individual surplus units in evaluating the
creditworthiness of deficit units.
• They diversify their loans among numerous deficit units and therefore can absorb
defaulted loans better than individual surplus units could.
Examples of Depository Institutions
o Commercial Banks- they serve surplus units by offering a wide variety of
deposit accounts, and they transfer deposited funds to deficit units by
providing direct loans or purchasing debt securities. Commercial bank
operations are exposed to risk because their loans and many of their
investments in debt securities are subject to the risk of default by the
borrowers. Commercial banks both serve the private and public sectors;
their deposit and lending services are utilized by the households,
business, and government agencies.

o Savings Institutions- sometimes referred to as thrift institutions. This

includes savings and loan associations and savings banks. Like
commercial banks, savings institutions offer deposit accounts to surplus
units and then channel this deposits to deficit units. Whereas commercial
banks concentrate in commercial (business) loans, savings institutions
concentrate on residential mortgage loans. Normally, mortgage loans are
perceived to exhibit a relatively low level of risk, but many mortgages
defaulted in 2008 and 2009. This led to the credit crisis and caused
financial problems for many savings institutions.

o Credit Unions- credit unions differ from commercial banks and savings
institutions in that they are (1) are non-profit and (2) restrict their business
to the credit union members, who share a common bond. Because of the
“common bond” characteristic, credit unions tend to be much smaller than
other depository institutions. They use most of their funds to provide loans
to their members.

Role of Nondepository Financial Institutions

Nondepository institutions generate funds from sources other than deposits but also play a
major role in financial intermediation.
Examples of Nondepository Institutions
o Finance Companies- most companies obtain funds by issuing securities
and then led the funds to individuals and small businesses. The functions
of finance companies and depository institutions overlap, although each
 type of institution concentrates on a particular segment of the financial
markets.

o Mutual Funds- mutual funds shares to surplus units and use the funds
received to purchase a portfolio of securities. They are the dominant non-
depository financial institution when measured in total assets. Some
mutual funds concentrate their investment in capital market securities,
such as stocks or bonds. Typically, mutual funds purchase securities in
minimum denominations that are larger than the savings of an individual
surplus unit.

o Securities Firms- securities firms provide a wide variety of functions in

financial markets. Some securities firms act as a broker, executing
securities transactions between two parties. The broker fee is reflected in
the difference (or spread) between the bid quote and the ask quote.
The mark up as a percentage of the transaction amount will likely to be
higher for less common transactions, since more time is needed to match
up buyers and sellers.

o Insurance Companies- provide individuals and firms with insurance

policies that reduce the financial burden associated with death, illness,
and damage to property. These companies charge premiums in
exchange for the insurance that they provide. They invest the funds
received in the form of premiums until the funds are needed to cover
insurance claims. Insurance companies commonly incest these funds in
stocks or bonds issued by corporations or in bonds issued by
government. In this way, they finance the needs of deficit units and thus
serve as important financial intermediaries.

o Pension Funds- Many corporations and agencies offer pension plans to

their employees. The employees and their employers (of both)
periodically contribute funds to the plan. Pension funds provide an
efficient way for individuals to save for their retirement. The pension funds
manage the money until the individuals withdraw the funds from their
accounts. The money that is contributed to individual retirement accounts
is commonly invested by the pension funds in stocks or bonds issued by
corporations or in bonds issued by government. Thus pension funds are
important financial intermediaries that finance the needs of deficit units.

Now that you are done with Lesson 1, would you like to find out how much you have learned
from this lesson?

Good job! Keep on reading the rest of the module to learn more. God Bless you!

Self-check

Directions: Perform the task indicated in the Google Classroom entitled Activity 1.1
Module 1
Lesson 2 INTEREST RATE DETERMINATION

Introduction

Interest rate movements have a direct influence on the market values of debt
securities, such as money market securities, bonds and mortgage, and have an indirect
influence in security values. Thus, participants in financial markets attempt to anticipate interest
rate movements when restructuring their positions. Interest rate movements also affect the
value of most financial institutions. The cost of funds to depository institutions and the interest
received o some loans by financial institutions are affected by interest rate movements. Since
many financial institutions invest in securities (such as bonds), the market value of their
investment is affected by interest rate movements. Thus, managers of financial institutions
attempt to anticipate interest rates movements so that they can capitalize on favourable
movements or reduce their institution’s exposure to unfavourable movements. Individuals
attempt to anticipate interest rate movements so that they can monitor the potential cost of
borrowing or the potential return from investing in various debt securities.

Learning Outcomes:

At the end of the lesson you will be able to:

✓ Apply the loanable funds theory to explain why interest rates change;
✓ Identify most relevant factors that affect interest rate movements.

Content Focus

LOANABLE FUNDS THEORY

The loanable funds theory, commonly used to explain interest rate movements, suggests that
the market interest rate is determined by factors controlling the supply of and demand for
loanable funds. The theory is especially useful for explaining movements in the general level of
interest rates. Furthermore, it can be used (along with other concepts) to explain why interest
rates among some debt securities of a given country vary.

• Household Demand for Loanable Funds

Households commonly demand loanable funds to finance housing expenditures.

In addition, they finance the purchases of automobiles and household items, which result
in instalment debt. As the aggregate level of household income rises, so does instalment
debt. The level of instalment debt as a percentage periods.

If household could be surveyed at any given time to indicate the quantity of

loanable funds they would demand at various interst rates levels, the results would
reveal am inverse relationship between the interest rate and the quantity of loanable
funds demanded. This simply means that, at any moment in time, households would
demand a greater quantity of loanable funds at lower rates of interest; in other words,
they are willing to borrow more money (in aggregate) at lower rates interest.
• Business Demand for Loanable Funds

Businesses demand for loanable funds to invest in long-term (fixed) and short-
term assets. The quantity of funds demanded by business depends on the number of
business projects to be implemented. Businesses evaluate a project by comparing the
present value of its cash flows to its initial investment, as follows:

where

Projects with a positive net present value (NPV) are accepted because the present value
of their benefits outweigh the costs. The required return to implement a given project will
be lower if interest rates are lower because the cost of borrowing funds to support the
project will be lower. Hence more projects will have positive NPV’s and businesses will
need a greater amount of financing. This implies that, all else being equal, businesses
will demand a greater quantity of loanable funds when interest rates are lower.
 In addition to long term assets, businesses also need funds to invest in
their short-term assets (such as accounts receivable and inventory) in order to support
on going operations. Any demands for funds resulting from this typ eof investment is
positively related to the number of projects implemented and thus is inversely yrealted to
the interest rate. The opportunity cost of in vesting in short term assets is higher when
interest rates are higher. Therefore, firms generally attempt to support on going
opeations with fewer funds during period of high interest rates. This is another reason
that a firm’s toatal demand for loanble funds is inversely related to prevailing rates than
others interest rates. Although the demand for loanable funds by some businesses may
be more sensititive to interest rates than others, all businesses are likely to demand
more funds when interest rates are lower.

• Government Demand for Loanble Funds

Whenever a government’s planned expenditures cannot be completely covered by
its incoming revenues from taxes and other sources, it demands loanble funds.
Municipal (state or local) governments issue municipal bonds to obtain funds, while the
federal governments and its agencies issue Treasury securities and federal agency
securities. These securities constitute government debt.
The federal government’s expenditures and tax policies are generally thought to be
independent of interest rates. Thus, the federal’s government demand for funds is
reffered to as interest-inelastic, or insensitive to interst rates. In contrast, municipal
government sometimes postpone proposed expenditures if the cost of financing is too
high, implying that their demand for loanable funds is somewhat sensitive to insterest
rates.
Like household and business demand, government demand for loananle funds can
shift in response to various events.
• Foreign Demand for Loanble Funds

The demand for loanable funds in a given market also includes foreign demand by
foreign governments or corporations. For expample, British government may obtain
financing by issuing British Treasury securities to U.S investors; this represents British
deamdn for U.S funds. Because foreign financial transactions are becoming so common,
they have a significant impact on the demand for loanable funds in any given country. A
foreign country’s demand for U.S funds is influenced by, among other factors, the
difference between its own interest rates and US rates. Other things being equal, a
larger quantity of U.S funds will be demanded by forign governments and corporations if
their domestic interest rates are high realtive to U.S rates. As a result, for a given set of
foreign interest rates, the quantity of U.S loanable funds demanded by foreign
governments or firms will be inversely related to U.S rates.

• Aggregate Demand for Loanable Funds

The aggregate demand for loanble funds is the sum of the quantities demanded
by the separate sectors at any given interest rate, as shown in exhibit 2.5. Because most
of these sectors are likely to demand a larger quantity of funds at lowe interest rate
(other things being equal), it follows that the aggregate demand for loanble funds is
inversely related to the prevailing interest rate. If the demand schedule of any sector
changes, the aggregate demadn schedule will also be affected.

• Supply of Loanble Funds

The term “supply of loanble funds” is comonly used to refer funds provided to
financial markets by savers. The household sector is the largest suppplier, but loanble
funds are also suppplied by some government units that temporarily generate more tax
revenues than they spend or by some businesses whose cash inflows exceed cash
outflows. Yet households as a group are anet supplier of loanable funds, whereas
governments and businesses are net demanders of loanable funds.
Suppliers of loanble funds are willing to supply more funds if the interest rate
(reward for supplying funds) is higher, other than being equal. This means that the
supply-of-loanble-funds schedule (also known the supply curve) is upward sloping, as
shown in exhibit 2.6. A supply of loanable funds exist at even a very low interest rate
because some household choose to postpone consumption until later years, even when
the reward (interest rate) for saving is low.
FACTORS THAT AFFECT INSTEREST RATE
Although it is useful to identify those who supply or demand loanable funds,it is
also necessary to recognize the underlying economic forces that cause a change in
either the supply of or the demand for loanable funds.The following economic factors
influence this supply and demand thereby influence interest rates.

• Impact of Economic Growth on Interest Rates

Changes in economic conditions cause a shift in demand curve for loanabe funds,
which affects the equilibrium interest rate.
• Impact of Inflation on Interest Rate

Changes in inflationary expectations can effect interest rates by affecting the

amount of spending by households or businesses.Decisions to spend affect the amount
saved (supply of funds) and the amount borrowed (demand for funds).
Fisher effect

More than 70 years ago ,Irving Fisher proposed a theory of interest rate
determination that is still widely used today.Its does not contradict the loanable funds
theory but simply offers an additional explanation for interest rate movements.Fisher
proposed that nominal interest payments compensate savers in two ways.First ,they
compensate for a saver’s reduced purchasing power.Second,they provide an additonal
premium to savers for forgoing present consumption .Savers are willing to forgo
consumption only if they received a premium on their savings above anticipated rate of
inflation, as shown in the following equation:

Where I = nominal or qouted rate of interest

E(INF) = expected inflation rate
= real interest rate

This relationship between interest rates and expected inflation is often referred to as the
Fisher effect. The difference between the nominal interest rate and the expected
inflation rate is the real return to saver after adjusting for the reduced purchasing power
over the time period of concern.It is referred to as the real interest rate because,unlike
the nominal rate of interest,its adjusts for the expected rate of inflation.The preceding
equation can be rearranged to express the real interest as

= i – E (INF)

When the inflation rate is higher than anticipated,the real interest rate is relatively
low. Borrowers benefit bacause they were able to borrow at a lower nominal interest rate
than would have been offered if inflation had been accurately forecasted. When the
inflation rate is lower than anticipated,the real interest rate is relatively high and
borrowers are adversely affected.

Thoughout the text,the term “interest rate” will be used tp represent the nominal, or
quoted,rate of interest.Keep in mind,however, that inflation may prevent purchasing
power from increasing during periods of rising interest rates.

Impact of Monetary Policy on interest Rates

The Federal Reverse can affect the supply of loanable funds by increasing or reducing
the total amount of deposits held at commercial banks or other depository
institutions.The process by which the Fed adjusts the money supply is described in
Chapter 4.When the Fed increases the money supply,it increases the supply of loanable
funds and this places downward pressure on interest rates.
Now that you are done with Lesson 2, would you like to find out how much you have learned
from this lesson?

Good job! Keep on reading the rest of the module to learn more. God Bless you!

Self-check

Directions: Perform Activity 1.2 indicated in the Google Classroom.

REFERENCES

JEFF MADURA (2014) Financial Institutions and Markets. CENGAGE Learning