Financial Markets And Monitory Policy For Phyllis Young


As the treasurer of a US-based manufacturing company, your task is to forecast the direction

of interest rates. You plan to borrow funds and may use the forecast of interest rates to

determine whether you should obtain a loan with a fixed interest rate or a floating interest

rate. The following information can be considered when assessing the future direction of

interest rates:

 Economic growth has been high over the last two years, but you expect that it will be

stagnant over the next year.

 Inflation has been 3 percent over each of the last few years, and you expect that it will

be about the same over the next year.

 The federal government has announced major cuts in its spending, which should have

a major impact on the budget deficit.

 The Federal Reserve is not expected to affect the existing supply of loanable funds

over the next year.

 The overall level of savings by households is not expected to change.


Question A:

Given the preceding information, determine how the demand for and the supply of loanable

funds would be affected, and determine the future direction of U.S. interest rates.


Question B:

You can obtain a one-year loan at a fixed-rate of 8 percent or a floating-rate loan that is

currently at 8 percent but would be revised every month in accordance with general interest

rate movements. Which type of loan is more appropriate based on the information provided?


Question C:

Assume that U.K. interest rates have abruptly risen just as you have completed your forecast

of future U.S. interest rates. Consequently, U.S. interest rates are now 2 percentage points

above U.S. interest rates. How might this specific situation place pressure on U.S. interest

rates? Considering this situation along with the other information provided, would you

change your forecast of the future direction of U.S. interest rates?

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