Personal Investment Management
ADMS 3531 Fall 2011 – Professor Dale Domian
Lecture 9 Part 1 – Interest Rates – Nov 15
Chapter 10 Outline
Interest rate history and money market rate.
Money market prices and rates.
Rates and yields on fixedincome securities.
The term structure of interest rates.
Nominal versus real interest rates.
Traditional theories of the term structure.
Determinants of nominal interest rates.
Our goal in this chapter is to discuss the many different interest rates that are commonly
reported in the financial press.
We will also:
o Find out how different interest rates are calculated and quoted, and
o Discuss theories of what determines interest rates.
Money Market Rates
Prime Rate – The basic interest rate on shortterm loans that the largest commercial banks
charge to their most creditworthy corporate customers.
Bellwether Rate – Interest rate that serves as a leader or as a leading indicator of future
trends, e.g. inflation.
Bank Rate – Interest rate that the Bank of Canada offers to commercial banks for
overnight reserve loans.
Call Money Rate – The interest rate brokerage firms pay for call money loans from
banks. This rate is used as the basis for customer rates on margin loans.
Commercial Paper – Shortterm, unsecured debt issued by the largest corporations.
Certificate of Deposit (CD) – Largedenomination deposits of $100,000 or more at
commercial banks for a specific term.
Banker’s Acceptance – A postdated check on which a bank has guaranteed payment.
Commonly used to finance international trade transactions.
London Eurodollars – Certificates of deposit denominated in U.S. dollars at commercial
banks in London. London Interbank Offered Rate (LIBOR) – Interest rate that international banks charge
one another for overnight Eurodollar loans.
Treasury Bill (TBill) – A shortterm federal government debt instrument.
Money Market Prices and Rates
A pure discount security is an interestbearing asset:
o It makes a single payment of face value at maturity.
o It makes no payments before maturity.
There are several different ways market participants quote interest rates.
o Banker’s discount basis.
o Bond equivalent yields (BEY).
o Annual percentage rates (APR).
o Effective annual rates (EAR).
The Bank Discount Basis
The bank discount basis is a method of quoting interest rates on money market
o It is commonly used for Tbills and banker’s acceptances.
More Ways to Quote Interest Rates
‘Simple’ interest basis – Another method to quote interest rates.
o Calculated just like annual percentage rates (APRs).
o Used for CDs.
o The bond equivalent yield on a Tbill with less than six months to maturity is also
An APR understates the true interest rate, which is usually called the effective annual rate
Rates and Yields on FixedIncome Securities
Fixedincome securities include longterm debt contracts from a wide variety of issuers:
o The Canadian government,
o Real estate purchases (mortgage debt),
o Corporations, and
o Provincial and municipal governments.
When issued, fixedincome securities have a maturity of greater than on year.
When issued, money market securities have a maturity of less than one year. The Treasury Yield Curve