Print this page Interest Rates
Lee Layton, P.E.
Course Outline
In this course we will look at the various terms that are used when describing interest rates. Terms such as nominal interest rates, real interest rates, basis points, annual effective rate, yield curves, etc, will be addressed.
The second section of the course is an overview of the various components that make up an interest rate including risk-free interest rate, inflation premium, default risk premium, maturity risk premium, and liquidity premium.
The final section includes a discussion of what several different interest rates such as the Federal Funds Rate, Discount Rate, Treasury Rates, Prime Rate, LIBOR and EURIBOR.
This course includes a multiple-choice quiz at the end, which is designed to enhance the understanding of the course materials.
Learning Objective
After taking this course you should,
- Know the components that make up an interest rate;
- Understand how the Federal government influences interest rates;
- Know the function of the Federal funds rate and the discount rate;
- Understand the difference between the prime rate and Libor;
- Understand the difference in the Federal Treasury rates;
- Understand the concept of “opportunity cost”;
- Know the difference between a nominal interest rate and an effective interest rate;
- Understand the concept of the Rule of 78’s’; and
- Know how interest rate swaps work.
Intended Audience
This course is intended for anyone who must perform economic analysis and that need to understand the time value of money and how it is valued.
Benefit to Attendees
After taking this course you will have a better understanding of what a given interest rate means and what to consider when selecting an interest rate for an economic analysis.
Course Introduction
Interest is, in effect, the rent paid for the use of money. It can be considered as a fee to borrow capital and the cost of credit. An interest rate, or more appropriately, the cost of capital, is a critical item in the economic analysis of engineering projects.
Interest is the price of using the property of another for a period of time. For instance, if you borrow money from a bank, you are in effect paying them rent for the use of their money. Just like renting an apartment, it is still their money and it must be returned to the owner at some point. This can be done at the end of the ‘rental period’ or the money can be returned over a period of time through an amortization of the loan amount.
Today there are many types of interest rates. Just look in the financial pages of any major newspaper and you will see many different interest rates published. The problem then is “which interest rate do I use for my analysis?” This course reviews the different types of interest rates, the make-up of an interest rate, and important interest rate terms.
The concept of interest is based on opportunity costs for the owner of the capital. As interest rates rise investors will want a higher rate for their investment, which means that fewer projects will qualify for capital. This means that fewer capital plant additions will occur and fewer workers will be hired and ultimately the economy will slow down. Likewise, lower interest rates make more projects attractive and make it easier for companies to acquire capital for new projects.
Interest rates follow the economics of supply and demand. When money is plentiful and opportunities are few, investors are willing to take a lower interest rate for the use of their money. In contrast, in tight money markets, investors may be more selective in which projects they will consider, thereby raising the cost of borrowing money.
Interest rates are generally thought of as either short-term rates or long-term rates. The definition of these two terms is not completely clear, but anything less than one-year is definitely short-term and anything longer than 10-years is considered long-term. Between one and ten years the definition would need to be based on what interest rate index is being considered. The Federal government essentially sets the short-term rates through its open market policies. However, as we will see shortly, the Federal government does not actually ‘set’ the interest rate, they merely set the targeted interest rate and their actions will tend to drive the actual rate toward their target. Long term rates are set by the market based on expectations of economic growth, inflation, and other market forces.
Course Content
This course content is in the following PDF document:
Please click on
the above underlined hypertext to view, download or print the document for your
study. Because of the large file size, we recommend that you first save the
file to your computer by right clicking the mouse and choosing "Save Target
As ...", and then open the file in Adobe Acrobat Reader. If you still experience
any difficulty in downloading or opening this file, you may need to close some
applications or reboot your computer to free up some memory.
Course Summary
In this course we have reviewed the various terms that are used when discussing interest rates. Terms such as nominal interest rates, real interest rates, basis points, annual effective rate, yield curves, interest rate swaps, etc, were reviewed.
The various components that make up an interest rate including risk-free interest rate, inflation premium, default risk premium, maturity risk premium, and liquidity premium have been discussed and finally we reviewed several of the major interest indices in use today such as the Federal Funds Rate, Discount Rate, Treasury Rates, Prime Rate, LIBOR and EURIBOR.
Quiz
Once you finish studying the above course content, you need to take a quiz to obtain the PDH credits.
DISCLAIMER: The materials contained in the online course are not intended as a representation or warranty on the part of PDH Center or any other person/organization named herein. The materials are for general information only. They are not a substitute for competent professional advice. Application of this information to a specific project should be reviewed by a registered architect and/or professional engineer/surveyor. Anyone making use of the information set forth herein does so at their own risk and assumes any and all resulting liability arising therefrom.
