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Financial markets & institutions

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Intros
Lessons
  2. Finance & Money, Wealth & Savings
    • Finance: Providing funds for expenditures on capital
    • Money: Commodity or Token for Goods & Services
    • Wealth: The Value of all Things One Owns
    • Saving: Leftover Income
  3. Finance Capital Market
    • Bond Markets
    • Loan Markets
    • Stock Markets
  4. Financial Institutions
    • Insurance Companies
    • Commercial Banks
    • Pension Funds
    • Government Sponsored Mortgage Lenders
  5. Financial Assets & Interest Rates
    • Financial Assets: Loans, bonds, stocks
    • Interest rate: Percentage of financial asset
    • Price of Asset  ↑ \, \uparrow \, , Interest rate  ↓ \, \downarrow \,
    • Price of Asset  ↓ \, \downarrow \, , Interest rate  ↑ \, \uparrow \,
Topic Notes
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Introduction to Financial Markets and Institutions

Welcome to the fascinating world of financial markets and institutions! These are the backbone of our modern economy, playing a crucial role in how money flows and how businesses and individuals access capital. Financial markets are where buyers and sellers trade various financial instruments, like stocks and bonds. On the other hand, financial institutions are the organizations that facilitate these transactions and provide financial services. Think of banks, insurance companies, and investment firms. Our introduction video is a great starting point to grasp these concepts. It breaks down complex ideas into easy-to-understand explanations, perfect for beginners. As we dive deeper into this topic, you'll see how these markets and institutions impact our daily lives, from saving for retirement to taking out a mortgage. Understanding these fundamentals is key to making informed financial decisions and navigating the economic landscape. So, let's get started on this exciting journey into the world of finance!

Understanding Finance, Money, and Wealth

What is Finance?

Finance is the broad term that encompasses the management of money, investments, and other financial instruments. It involves the study of how individuals, businesses, and organizations acquire, allocate, and use monetary resources over time. Finance plays a crucial role in decision-making processes, risk management, and long-term planning.

Key Aspects of Finance:

  • Personal finance: Managing individual or family budgets, savings, and investments
  • Corporate finance: Handling financial decisions for businesses and organizations
  • Public finance: Dealing with government budgets, taxes, and spending

Understanding Money

Money is a medium of exchange that serves as a universally accepted means of payment for goods and services. It functions as a store of value and a unit of account. Money can take various forms, including physical currency (coins and banknotes), digital currency, and other financial instruments.

Functions of Money:

  • Medium of exchange: Facilitates transactions and trade
  • Store of value: Allows wealth to be preserved over time
  • Unit of account: Provides a standard measure for pricing goods and services

Defining Wealth

Wealth refers to the total value of an individual's or entity's assets minus their liabilities. It encompasses both financial and non-financial resources that contribute to economic well-being. Wealth can be accumulated through savings, investments, and the acquisition of valuable assets.

Components of Wealth:

  • Financial capital: Cash, stocks, bonds, and other financial instruments
  • Physical capital: Real estate, vehicles, and other tangible assets
  • Human capital: Skills, knowledge, and earning potential
  • Social capital: Networks and relationships that can provide economic benefits

Differences Between Finance, Money, and Wealth

While these concepts are interconnected, they have distinct characteristics:

  • Finance is the overarching system of managing monetary resources
  • Money is a tool used within the financial system for transactions and value storage
  • Wealth is the result of effective financial management and accumulation of valuable assets

The Role of Savings in Building Wealth

Savings play a crucial role in the journey from managing money to building wealth. By setting aside a portion of income regularly, individuals can:

  • Create an emergency fund for unexpected expenses
  • Invest in opportunities for future growth
  • Achieve long-term financial goals, such as homeownership or retirement

The Importance of Financial Literacy

Understanding the concepts of finance, money, and wealth is essential for making informed financial decisions. Financial literacy empowers individuals to:

  • Manage personal finances effectively
  • Make wise investment choices
  • Plan for a secure financial future
  • Navigate complex financial products and services

Conclusion

Finance, money, and wealth are interconnected concepts that play vital roles in our economic lives. Finance provides the framework for managing monetary resources, money serves as the medium for transactions and value storage, and wealth represents the accumulation of valuable assets. By understanding these concepts and developing strong financial literacy skills, individuals can make informed decisions to improve their financial well-being and build lasting wealth.

Financial Capital Markets: Bonds, Loans, and Stocks

Financial capital markets play a crucial role in the global economy, facilitating the flow of funds between investors and borrowers. These markets are essential for economic growth, providing opportunities for businesses to raise capital and investors to grow their wealth. The three main types of financial capital markets are the bond market, loan market, and stock market. Each of these markets operates differently and serves specific purposes in the financial ecosystem.

Bond Market

The bond market, also known as the debt market or credit market, is where debt securities are issued and traded. Bonds are essentially loans made by investors to borrowers, typically governments or corporations. When an entity issues a bond, it promises to repay the principal amount along with interest over a specified period.

Key features of the bond market include:

  • Fixed income: Bonds provide regular interest payments, making them attractive to investors seeking steady income.
  • Varying maturities: Bonds can have short-term (less than one year) to long-term (30 years or more) maturities.
  • Risk levels: Government bonds are generally considered low-risk, while corporate bonds carry higher risk but potentially higher returns.
  • Secondary market: Bonds can be traded on secondary markets, allowing investors to buy and sell before maturity.

Example: A corporation might issue a 10-year bond with a 5% annual interest rate to raise capital for expansion. Investors purchase these bonds, receiving regular interest payments and the principal amount at maturity.

Loan Market

The loan market involves financial institutions, primarily banks, providing loans to individuals, businesses, and other entities. Unlike bonds, loans are typically not traded on secondary markets and are held by the lending institution until repayment.

Characteristics of the loan market include:

  • Direct lending: Banks and other financial institutions lend directly to borrowers.
  • Customized terms: Loan terms can be tailored to the borrower's needs and creditworthiness.
  • Secured and unsecured options: Loans may be backed by collateral (secured) or based solely on the borrower's creditworthiness (unsecured).
  • Various purposes: Loans can be used for personal needs, business operations, real estate purchases, and more.

Example: A small business owner might obtain a $100,000 loan from a local bank to purchase new equipment. The loan terms could include a 7% interest rate, monthly repayments over five years, and the equipment serving as collateral.

Stock Market

The stock market is where shares of publicly traded companies are bought and sold. When a company issues stock, it's selling ownership stakes to investors. The stock market allows companies to raise capital and provides investors with opportunities for potential growth and income through dividends and capital appreciation.

Key aspects of the stock market include:

  • Equity ownership: Stockholders become partial owners of the company they invest in.
  • Price volatility: Stock prices can fluctuate significantly based on various factors, including company performance, economic conditions, and market sentiment.
  • Dividend potential: Some stocks pay regular dividends, providing income to shareholders.
  • Liquidity: Stocks can be easily bought and sold on exchanges, providing high liquidity for investors.

Example: An investor purchases 100 shares of a technology company at $50 per share. If the company performs well and the stock price rises to $60, the investor's investment value increases by 20%. Additionally, if the company pays a quarterly dividend of $0.25 per share, the investor receives $100 in annual dividend income.

Understanding these three main types of financial capital markets is essential for both investors and businesses. The bond market offers relatively stable, fixed-income investments and allows entities to raise capital through debt issuance. The loan market provides customized financing solutions for various needs, facilitating economic activity

Financial Institutions and Their Roles

Financial institutions play a crucial role in the modern economy, facilitating various financial transactions and providing essential services to individuals, businesses, and governments. This article explores four key types of financial institutions: insurance companies, commercial banks, pension funds, and government-sponsored mortgage lenders. Each of these institutions serves unique functions in the financial market, contributing to economic stability and growth.

Insurance Companies

Insurance companies are financial institutions that provide protection against various risks in exchange for premium payments. These companies offer a wide range of insurance products, including life, health, property, and casualty insurance. The primary function of insurance companies is to pool risks from multiple policyholders and provide financial compensation in the event of covered losses. In addition to risk management, insurance companies also act as significant institutional investors in the financial markets, using premium income to invest in various securities and assets to generate returns and meet future claim obligations.

Commercial Banks

Commercial banks are perhaps the most familiar type of financial institution to the general public. These banks serve as intermediaries between depositors and borrowers, accepting deposits from individuals and businesses and using those funds to provide loans and other financial services. The primary functions of commercial banks include:

  • Accepting deposits and maintaining checking and savings accounts
  • Providing loans to individuals and businesses
  • Facilitating payment systems and money transfers
  • Offering financial advice and wealth management services
Commercial banks play a crucial role in the economy by creating money through the fractional reserve banking system and facilitating the flow of funds between savers and borrowers.

Pension Funds

Pension funds are financial institutions that manage retirement savings for employees on behalf of their employers. These funds collect contributions from both employees and employers, investing the pooled assets to generate returns that will fund future retirement benefits. The primary functions of pension funds include:

  • Collecting and managing retirement contributions
  • Investing assets to generate long-term returns
  • Providing retirement benefits to plan participants
  • Managing risk to ensure the fund's long-term sustainability
Pension funds are significant institutional investors in the financial markets, often holding large portfolios of stocks, bonds, and other assets. Their investment decisions can have a substantial impact on financial markets and the broader economy.

Government-Sponsored Mortgage Lenders

Government-sponsored mortgage lenders, also known as government-sponsored enterprises (GSEs), are financial institutions created by the government to support specific sectors of the economy, particularly the housing market. In the United States, prominent examples include Fannie Mae and Freddie Mac. The primary functions of these institutions include:

  • Purchasing mortgages from lenders to increase liquidity in the mortgage market
  • Securitizing mortgages into mortgage-backed securities for sale to investors
  • Providing guarantees on mortgage-backed securities to reduce investor risk
  • Promoting homeownership by making mortgages more accessible and affordable
These institutions play a crucial role in supporting the housing market and ensuring a steady flow of credit to homebuyers.

In conclusion, insurance companies, commercial banks, pension funds, and government-sponsored mortgage lenders each serve unique and essential functions in the financial market. Insurance companies provide risk management solutions and act as institutional investors. Commercial banks facilitate the flow of funds between savers and borrowers while providing essential financial services. Pension funds manage retirement savings and invest in various assets to generate long-term returns. Government-sponsored mortgage lenders support the housing market by increasing liquidity and making mortgages more accessible. Together, these institutions form a complex and interconnected financial ecosystem that supports economic growth, stability, and individual financial well-being.

Financial Assets and Interest Rates

Hey there, finance enthusiast! Let's dive into the fascinating world of financial assets and their dance with interest rates. It's like a financial tango, and I'm here to break it down for you in a way that's easy to understand.

First things first, what are financial assets? Well, they're like little pieces of financial value that you can own. Think stocks, bonds, certificates of deposit (CDs), and even your savings account. These assets are the building blocks of investments and play a crucial role in our economy.

Now, let's talk about interest rates. They're like the heartbeat of the financial world, influencing everything from your mortgage to big corporate investments. Interest rates are essentially the cost of borrowing money or the reward for saving it.

Here's where it gets interesting: financial assets and interest rates have a special relationship. They're like two dancers on a financial dance floor, always moving in response to each other. When one moves, the other reacts.

Let's take bonds as an example. Bonds are a type of financial asset where you lend money to a company or government, and they promise to pay you back with interest. The price of a bond and its interest rate (also called yield) move in opposite directions. It's like a seesaw!

Imagine you have a bond that pays $50 a year in interest, and it's worth $1,000. The yield would be 5% ($50 ÷ $1,000 = 0.05 or 5%). Now, if interest rates in the broader economy rise to 6%, what happens? Your 5% bond doesn't look so attractive anymore, right? So, the price of your bond would fall.

Let's say it falls to $833.33. At this new price, the $50 annual interest payment now represents a 6% yield ($50 ÷ $833.33 = 0.06 or 6%). The bond's price adjusted to match the new interest rate environment.

This relationship works the other way too. If interest rates fall, existing bonds become more valuable because their interest payments are now above market rates. Their prices would rise until their yield matches the new, lower interest rates.

But it's not just bonds that dance with interest rates. Stocks can be affected too. When interest rates rise, it can make borrowing more expensive for companies, potentially reducing their profits. This might make stocks less attractive, causing their prices to fall. On the flip side, when rates are low, companies can borrow cheaply to expand, potentially boosting their profits and stock prices.

Let's look at another example with a different type of asset: a certificate of deposit (CD). Say you have a 1-year CD paying 2% interest. If market interest rates suddenly jump to 3%, your CD is now less valuable compared to new CDs being offered. You're locked into a lower rate. But if you were to buy a new CD after rates rose, you'd benefit from the higher interest rate.

Here's a quick calculation to show how this works: If you invest $10,000 in a 2% CD, after a year you'd have $10,200 ($10,000 × 1.02). But if you could invest at 3%, you'd end up with $10,300 ($10,000 × 1.03). That's an extra $100 just from a 1% difference in interest rates!

Understanding this relationship between financial assets and interest rates is crucial for making informed investment decisions. It helps explain why your bond portfolio might lose value when interest rates rise, or why your stocks might soar when rates are cut.

Remember, though, that while this relationship is generally true, real-world markets are complex. Many factors influence asset prices, not just interest rates. Things like economic growth, inflation, and even geopolitical events can all play a role.

So, next time you hear about the Federal Reserve changing interest rates, think about how it might affect your financial assets. Are your bonds going to do a little dance? Will your stocks take a bow? It's all part of the grand performance of the financial markets!

Keep exploring and learning about these fascinating relationships in finance. The more you understand, the

Impact of Interest Rates on Firms and Financial Markets

Interest rates play a crucial role in shaping the financial landscape for firms and overall market conditions. Changes in interest rates can significantly affect a company's ability to manage debt and influence broader economic trends. When interest rates fluctuate, it creates a ripple effect throughout the financial ecosystem, impacting borrowing costs, investment decisions, and market stability.

When interest rates increase, firms face higher costs for borrowing money. This can strain their ability to pay existing debts and make it more challenging to secure new loans for expansion or operations. For example, during the Federal Reserve's rate hikes in 2022, many companies experienced increased pressure on their balance sheets. Tech giants like Meta and Amazon saw their debt servicing costs rise, leading to cost-cutting measures and slower growth projections.

Conversely, when interest rates decrease, firms generally find it easier to manage their debt obligations. Lower rates reduce the cost of borrowing, allowing companies to refinance existing debts at more favorable terms. This was evident during the COVID-19 pandemic when central banks worldwide slashed interest rates to near-zero levels. Many corporations took advantage of this low-rate environment to issue new bonds and restructure their debt portfolios.

The impact of interest rate changes extends beyond individual firms to shape overall financial market conditions. Rising rates typically lead to a contraction in the money supply, as borrowing becomes more expensive. This can result in slower economic growth and potentially trigger a recession if the rate hikes are too aggressive. The 2008 financial crisis serves as a stark reminder of how rapid interest rate increases can contribute to market instability and economic downturns.

On the other hand, decreasing interest rates often stimulate economic activity by encouraging borrowing and investment. This was evident in the years following the 2008 crisis when low interest rates helped fuel a bull market and economic recovery. However, prolonged periods of low rates can also lead to asset bubbles and excessive risk-taking, as investors search for higher yields in riskier assets.

For financial markets, interest rate changes influence asset valuations across various sectors. Bond prices, for instance, move inversely to interest rates. When rates rise, existing bonds become less attractive, causing their prices to fall. This dynamic was clearly demonstrated in 2022 when the global bond market experienced significant losses due to rapid rate hikes by central banks combating inflation.

In conclusion, the relationship between interest rates, firm debt, and financial market conditions is complex and multifaceted. Changes in rates can have profound implications for corporate financial health, economic growth, and market stability. As such, both firms and investors must remain vigilant and adaptable to navigate the ever-changing interest rate environment effectively.

Conclusion: The Interconnected World of Finance

In this comprehensive exploration of financial markets and institutions, we've delved into the intricate web that forms the backbone of our global economy. From the bustling stock exchanges to the complex operations of banks and investment firms, we've uncovered the vital roles these entities play in shaping our financial landscape. Understanding these financial markets and institutions is crucial for anyone looking to navigate the modern economic world effectively. The introduction video provided a solid foundation, offering key insights into the fundamental concepts that drive these systems. As we've seen, the interplay between various financial instruments, regulatory bodies, and market participants creates a dynamic environment that influences everything from personal savings to international trade. We encourage you to continue exploring this fascinating topic, as a deeper understanding of financial markets and institutions can empower you to make informed decisions, whether you're an individual investor, a business owner, or simply a curious observer of economic trends. The knowledge gained here is just the beginning of a journey towards greater financial literacy and economic understanding.

Finance & Money, Wealth & Savings

  • Finance: Providing funds for expenditures on capital
  • Money: Commodity or Token for Goods & Services
  • Wealth: The Value of all Things One Owns
  • Saving: Leftover Income

Step 1: Understanding Finance

Finance is the act of finding and providing funds to pay for expenditures on capital. For instance, if a company wants to expand its business, it needs money. This money can be obtained through various means such as loans, investments, or stock purchases. The process of acquiring these funds is known as financing. It is crucial to study how households and firms obtain these funds and manage the associated risks. Financing helps businesses grow by providing the necessary capital for expansion.

Step 2: Understanding Money

Money is any commodity or token that is accepted as payment for goods and services. It is used to facilitate financial transactions. Examples of money include dollar bills, which are commodities or tokens exchanged for goods. While finance and money are closely related, they are not the same. Money is used to finance projects, but finance involves the broader process of acquiring and managing funds.

Step 3: Understanding Wealth

Wealth is the value of all items and money that a person owns. It differs from income, which is the money earned during a specific time period. Wealth encompasses all assets and money a person has, regardless of the time period. It includes everything a person owns, such as money, properties, and other valuable items.

Step 4: Understanding Savings

Saving is the portion of income that is not used for consumption, goods, services, or taxes. For example, if a person earns $100, they might spend some on food and save the rest. Savings represent the money set aside and not spent on goods or taxes. The more a person saves, the higher their wealth becomes, as savings contribute to the accumulation of wealth.

Step 5: Understanding Physical and Financial Capital

Physical capital refers to tangible assets such as tools and equipment used in a company. Financial capital, on the other hand, includes all the money and assets owned by the company that are used to produce goods and services. Physical capital is about the physical tools and equipment, while financial capital encompasses the monetary resources and assets.

FAQs

  1. What are the main types of financial markets?

    The main types of financial markets include stock markets (for trading company shares), bond markets (for debt securities), money markets (for short-term debt instruments), foreign exchange markets (for currency trading), and derivatives markets (for contracts based on underlying assets).

  2. How do interest rates affect financial markets?

    Interest rates significantly impact financial markets by influencing borrowing costs, investment decisions, and asset valuations. Higher rates typically lead to lower bond prices, potentially slower economic growth, and can affect stock market performance. Lower rates often stimulate borrowing and investment but may lead to asset bubbles if maintained for too long.

  3. What role do commercial banks play in the financial system?

    Commercial banks are crucial intermediaries in the financial system. They accept deposits, provide loans, facilitate payment systems, and offer various financial services. Banks create money through the fractional reserve system and play a vital role in implementing monetary policy and maintaining economic stability.

  4. How do pension funds contribute to financial markets?

    Pension funds are significant institutional investors that manage retirement savings for employees. They contribute to financial markets by investing in various assets like stocks, bonds, and real estate. Their large-scale investments can influence market trends and provide capital for businesses and governments.

  5. What is the difference between stocks and bonds?

    Stocks represent ownership in a company, while bonds are debt instruments. Stockholders potentially benefit from company growth and may receive dividends, but face higher risk. Bondholders receive fixed interest payments and have priority in case of bankruptcy, but typically have limited upside potential compared to stocks.

Prerequisite Topics

Understanding financial markets and institutions is a complex subject that requires a solid foundation in various economic and financial concepts. While there are no specific prerequisite topics provided for this subject, it's important to recognize that a broad understanding of economics, finance, and business principles can greatly enhance your comprehension of financial markets and institutions.

Financial markets and institutions play a crucial role in the global economy, facilitating the flow of funds between savers and borrowers, and providing essential services for individuals, businesses, and governments. To fully grasp the intricacies of this field, students should have a strong grasp of basic economic principles, such as supply and demand, market equilibrium, and the role of government in the economy.

Additionally, a fundamental understanding of financial concepts is vital. This includes knowledge of financial instruments, such as stocks, bonds, and derivatives, as well as an understanding of risk and return. Familiarity with accounting principles can also be beneficial, as it helps in interpreting financial statements and assessing the health of financial institutions.

Mathematics, particularly statistics and probability, forms another important foundation for studying financial markets and institutions. These skills are essential for analyzing market trends, assessing risk, and making informed financial decisions. Proficiency in these areas can significantly enhance a student's ability to understand complex financial models and theories.

Moreover, an awareness of current events and global economic trends is crucial. Financial markets are heavily influenced by geopolitical events, economic policies, and technological advancements. Staying informed about these factors can provide valuable context for understanding market behaviors and institutional decisions.

While specific prerequisite topics may not be listed, developing a broad knowledge base in economics, finance, mathematics, and current affairs can significantly enhance your understanding of financial markets and institutions. This multidisciplinary approach allows students to connect various concepts and see the bigger picture of how financial systems operate in the real world.

As you delve into the study of financial markets and institutions, you'll find that your knowledge in these foundational areas will be continuously applied and expanded. The interconnected nature of financial systems means that understanding one aspect often requires knowledge of several others. Therefore, maintaining a curious and open mindset, and being willing to explore related topics as they arise, is key to success in this field.

In conclusion, while there may not be a strict list of prerequisites, approaching the study of financial markets and institutions with a well-rounded background in economics, finance, mathematics, and current affairs will provide you with the tools necessary to navigate this complex and dynamic field effectively.


Finance & Money, Wealth & Saving

To understand financial markets and financial institutions, we first need to understand the difference between the following,
  1. Finance & Money
  2. Wealth & Saving
  3. Physical & Financial Capital


Finance: the act of finding and providing funds which help pay for expenditures on capital.

When we study finance, want to see how households and firms obtain these funds, and how they deal with risks when they are financing.

Money: is any commodity or token that is acceptable as payment for goods and services. It is what we use to make financial transactions.

Finance and money are closely related, but they are not the same. Money is what you use to finance a project.

Note: In this chapter, we will mostly be focusing on finance.

Wealth: is the value of all items and money that a person owns. This is different from income, since that’s the money you earn during a time period.

Saving: the income that is not used on consumptions goods and services and tax.

Note: The more you save, the higher your wealth is.

Financial Capital Markets

We use savings as a source of the funds to finance investments. These funds are then supplied and demanded to three markets:
  1. Bond Markets
  2. Loan Markets
  3. Stock Markets


Bond Markets: When firms expand its business and open new stores, it is going to need money to do so. They get the money by selling bonds.

A bond is a fixed income investment that represents a loan made by an investor to a borrower. The investor gives a loan to a borrower, and the borrower pays a specific amount at a specific time period until the final payment is done.

Example: Person A loans firm $100. Firm pays person A $5 every year until 2050, where the firm pays the last $5 and also the loan amount ($100).

Firms use to this to get their money first, and then pay back later including interest.

Loan Market: Firms get money to expand their business by loaning from a bank.

For example, bank loans the firm $100 with an interest rate of 5%. The firm must pay back $100 including an additional $5 next year (total $105).

Households can also get financing for new homes by getting a mortgage from banks.

Stock Market: Firms can get money to expand their business by issuing stocks. A stock is a legal ownership which allows you to claim a certain percentage of the firm’s profits.

Example: If a firm has 100 stocks and you own 1 of them, then you are entitled to get 1% of the firm’s profits.

Financial Institutions

A financial institution is firm that conducts financial transactions like investments, loans and deposits. They operate on both sides of the market. In other words, they can be a borrower in one market, and a lender in another.

The 4 following financial institutions are:
  1. Insurance Companies: these companies allow households to deal with risks like theft, fire, death, and accidents. They receive premiums from clients and pay claims. They use statistical analysis to find out their actual losses for a given class, and by that they can calculate what the premiums should cost. This gives them a steady flow of funds.

  2. Commercial Banks: they accept deposits, give payment services to other institutions, and make loans to households and firms. You will learn more about how they manage their money later.

  3. Pension funds: uses pension contributions from workers and firms to buy bonds and stocks. There are pension funds that are extremely high, so they have a lot of power to what stock they want to hold.

  4. Government-sponsored mortgage lenders: In simple terms, they are large financial institutions that buy mortgages from banks, make them into mortgage-backed securities, and sell them.


Financial Assets & Interest Rates

Loans, bonds, and stocks are all known as financial assets.

The interest rate of a financial asset is the interest received from the percentage of the price of the asset.

Essentially:
  1. If price of asset  ↑ \, \uparrow \, , then interest rate  ↓ \, \downarrow \, .
  2. If price of asset  ↓ \, \downarrow \, , then interest rate  ↑ \, \uparrow \, .


Suppose the price of the asset (bond) is $100, and the interest received is $5 per year. So,

Interest Rate = 5100 ×100\frac{5} {100} \, \times 100 = 5%

  1. If the price of asset is now $110, then

    Interest Rate = 5110 ×100=4.54‾\frac{5} {110} \, \times 100 = 4.\overline{54}%
  2. If the price of asset is now $90, then

    Interest Rate = 590 ×100=5.55‾\frac{5} {90} \, \times 100 = 5.\overline{55}%

Note: If interest rate increases, then price of asset decreases, which makes it hard for firms to pay their debts.