business-man.biz — this is a site about business, you can find here a big library of articles about business, bankruptcy, credit cards, banks, loans and currency trading.

Finance

A Short Concise Primer On Interest Rates

First, what interest rates are we talking about and why is it important to both the economy and business decisions?

There is an old saying that money makes the world go around. In economic parlance this is not quite correct. Actually, it is the cost of money that makes the world go around, and this cost of money is reflected in the level of interest rates. As the level of interest rates rise, businesspeople and investors demand a higher rate-of-return on their capital investment to justify the expenditure. The result is similar to ?walking up a pyramid? in that fewer and fewer capital expenditures can justify the targeted rate-of-return. As productive investment decreases, so does the speed at which money circulates (its velocity). With some lag time the economy begins to slow and unemployment starts to increase.

With such importance attached to interest rates, does the Federal Reserve Board (FED) really control their level? To simplify, we must differentiate between short-term and long-term rates. Interest rates on securities that mature in less than a year would be considered short-term, while interest rates on securities that mature in over 10 years would denote long-term rates.

The FED through its open market policies does have a powerful impact on short-term interest rates, namely the federal funds rate and its brother, the three-month Treasury bill rate. The federal funds rate is an overnight rate at which banks lend to each other.

Long-term interest rates, however, are set more by the market than by the FED. These rates reflect peoples? expectations of economic growth, both real and inflationary. When a businessman issues a 20-year bond yielding 10% interest per year, he is assuming the funds can be profitably invested in an enterprise earning significantly better than 10%. If this isn?t so, why borrow the money at 10%?

The movement of interest rates can give us a clue as to the future direction of the economy. It is not the absolute level of short-term or long-term rates that is important--it is the spread between them. For example, if long-term Treasury bonds are yielding 5% and the 90-day Treasury bills are yielding 2%, then the spread is three percentage points.

As the FED tightens-up on the money supply, short-term rates will climb faster than long-term rates. If short-term interest rates start to climb above long-term rates (as happened in l979, l980, l981, and in year 2000), this is an early warning sign that the economy will be slowing significantly--possibly entering a business recession.

As this happens, it would be best to reduce your short-term debt levels and start to rebuild liquidity. Business slowdowns or recessions can be times of great opportunities, but only for those who have the resources. The future belongs to the swift--Liquidity is King!

Sanford Kahn, Business Author/Speaker, has been a professional speaker for over 30 years to both the corporate and national trade and professional association markets. He was the host and producer of the popular Times mirror cable vision series "Ask the Economist". Mr. Kahn has authored many articles on the business impact of future economic trends. His most recent publication is The Great Economic & Business Myths That Dominate Our Lives. For more information please visit his web page at http://www.businessspeaker.biz.

Sanford Kahn

← Previous Next →

Similar articles

33 Essential Year-End Financial Tasks

The end of the year is a traditional time of celebration, excitement, reflection and planning ? not withstanding the hectic holiday shopping of course. Read more →

A Brief History of Banking

If you've ever wondered exactly how it is that modern banking originated, you're not alone. Though many of the practices of modern banking have come about only within the past one hundred years (or less), some of the early basis for modern banking can be traced back to the Middle Ages and before. Read more →

A Visa Gift Card Is A Thoughtful Gift

If you are considering giving a gift to a friend, neighbor, family member, or co-worker, then consider giving a gift card instead of a present. Gift cards allow recipients to choose the gift that befits them and in many cases the card can be used at many different locations, especially if it is a Visa gift card. Read more →

After the Patriot Act - How to Take Back Your Privacy

In recent years we have seen a dramatic decline in personal privacy in the Land of the Free. Vast amounts of data including financial transactions and phone calls are being recorded on each citizen and since virtually all of our financial activities are tied to our Social Security Number this information is neatly compiled and easily available to the government, private investigators and even through the Internet. Read more →

Our site is presents documentation and articles for creating and improving your business.

© 2007. If you will use information from our site, please don't forget about hiperlink (<a href="http://articles.business-man.biz">Business articles for businessmen</a>)