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WRITE A RESPOND TO THE 5 QUESTIONS               DUE    8/31/2016

COMPONENTS OF INTEREST RATES

1.      Consider an interest rate. While this may look like a simple number from the outside, there is more to this number than first meets the eye. Many components make up an interest rate. Whether you're seeking to borrow, to invest or both, it's important to understand the reasons for differences among interest rates. Let’s take a peek inside. First, it’s helpful to understand that lenders want to earn money on the money they lend. They do this by charging rent on the money they offer, in much the same way that property owners charge rent. For an interest rate, rent is calculated on an annual basis, somewhere in the range of 1%-2%. On top of this basic compensation, we have to consider inflation. Interest rates and inflation go hand in hand because lenders must account for the amount of value they expect their money to lose over time. Add 2%-3% to cover the annual rate of inflation. Together, the rent and inflation represent a safe minimum or risk-free rate of return an investor expects. It is standard practice to use the U.S. 90-day T- Bill as a benchmark for the risk-free rate. But what accounts for the rest of the interest rate? Risk premiums represent the amount of interest the lender adds to the risk-free rate to compensate for uncertain payoff. In other words, lending is somewhat like placing a bet. The riskier the bet payoff appears to the lender, the higher the risk premiums. For individual borrowers, there are several risk factors you can evaluate: credit scores, home ownership, length of employment, etc. Each of these factors can contribute to the risk premium. It’s easy to see how these risks add up. For business borrowers, you would consider a different set of risk factors, such as experience of management, length of time in business, debt carried, etc. But still there are other risk premiums that we can categorize as psychological factors. What is your confidence in the market or in the future value of the dollar? Real and perceived risks influence investment decisions. The more risk averse you are, the more likely you are to put your money into a safe investment like the T-Bill... or you add premiums to the interest rate to hedge the riskier bet on your money. Because of all these variables, interest rates are always changing. Rent and inflation comprise the risk-free rate. Risk premiums are added based on the borrower’s profile and the lender’s perceptions. By understanding the components of interest rates, you can knowledgeably negotiate financing decisions as lender or borrower.

 

CURRENTCREEDIT MARKET

2.      Varying situations in the credit market greatly affect an organization’s financial decision making. All organizations use the credit market in some way. For example, many firms look at the yield curve as a predictor of the business cycle. Other important aspects of the credit market include interest rates, bonds, and the cost of capital. As a business manager, you must analyze, review, and understand the current credit market to make sound financial decisions. Locate an article about the current credit market. Create a chart or graph depicting the key points of the article.

 

GLOBAL ECONOMIS CONDITION ANALYSIS

3.      All organizations are affected by international markets. Whether an organization is considered an international or domestic organization, international markets affect the way an organization makes business decisions. For example, an organization might only provide domestic services, but the organization might use products or components from international companies. Perhaps an organization’s output is domestic, but its input is international. In this case, the international exchange rate affects the domestic product. Understanding the global economy is important for all types of organizations.

Select a country other than the country in which you currently reside that is part of a trade bloc and research the EIU Country Data or Country watch located in the University Library. Based on absolute advantage and comparative advantage, explain 3 to 5 effects of global economic conditions on the choices available to that trading bloc. Include the current exchange rate of the country with other members of the trade bloc. You may want to consider the value of examining the effects of global economic conditions using data from the entire trading bloc instead of data from only one country.

 

MONEY MULTIPLIER

4.      Narrator: There are trillions of dollars in circulation in the United States today. How is all that money created? The process is simple. So let’s say you deposit $1,000 into the bank. Your deposit allows that bank to make profitable loans they otherwise couldn't make. Now, let’s say your bank lends out 90% of the $1,000, keeping 10% in reserve. Reserves is the money a bank keeps on hand to manage the normal cash deposits and withdrawals. Banks are required to hold a percentage of deposits, called the required reserve ratio. So, you deposited $1,000, and now the Bank lends out $900 to someone else. That borrower now has $900, and you still have $1,000, so now there’s $1,900 dollars of money. By making the loan, the bank has created $900 in money. And no one borrows money just to hold it. So, let’s say that borrower spends his $900 on a plane ticket. The airline now has $900 that is deposited back into the bank. The bank loans $900 out and gets $900 back in. And, it continues. Now the bank lends $810, keeping $90 in reserve. The story repeats itself and repeats itself: Lend 90%, keep 10%, and money is created each time. So what’s the total amount of money being created? Well economists have come up with an equation for that, called the money multiplier. Just multiply the initial $1,000 by 1 divided by the reserve ratio. The $1,000 that you gave to the bank is now the reserve, which means that $9,000 has been created by the process. Almost like magic. But what happens when people can’t repay their loans to the bank? Well, when loans are high-risk, banks stop lending. Remember the required reserve ratio? Banks can opt to hold an additional percentage called the excess reserve ratio. So, let’s say you deposit $1,000, and the bank is required to keep 10% in reserve, and it also keeps 10% in excess reserves. How much money will be created by the bank? Use the money multiplier. One thousand multiplied by one divided by two-tenths is... five thousand. Five thousand minus one thousand is four thousand. VIDEO TRANSCRIPT © University of Phoenix 2014 Money Multiplier Page 2 Now think of all the money being created from deposits made every day, all over the nation. That’s a LOT of money.

 

Buy American

5.      I have heard the term "Buy American" many times, especially when it came to purchasing my vehicle. Several people informed me to purchase an American automobile because foreign vehicles are more expensive to maintain and purchasing the necessary parts to "fix" the vehicle would be very expensive in comparison to parts for an American made car. This concept really does sound good; however, having that type of mentality can have a negative impact on the global economy. If citizens of a country decided to purchase only the products that were made in their country, they would be at a disadvantage because other countries would get wind and decide not to import any of their goods. Although imports would be reduced, exports will also decrease and according to Markeim (2009), this can lead to a loss of jobs which can have a trickle effect, leading to a slow economy.

 

 

Markheim, D. (2009). Buy American Hurts America. Retrieved from http://www.heritage.org/research/reports/2009/01/buy-american-hurts-america

 

 

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