1. How does fisher affect the market interest rate?

o Fisher effect describes the relationship between real and nominal interest rate. Fisher
effect state that Real interest rate = Nominal interest rate – expected inflation hence,
while inflation rate increase, real interest rate decreases, unless nominal interest rate
also increase at same rate as inflation. As to investors, it is important that real interest
rate is positive for them to assure they are earning during the inflation

Example:

I have a 5000 peso and I plant to buy an aircon worth 5000-peso next month. For the
mean time, I place my 5000 peso at my savings account in bank, where the bank offer a 8%
interest rate ( 8% is my nominal rate). And there is an expected inflation of 10% in aircon during
that week. So, according to fisher effect my real interest rate should be -2%, where I should
have a shortage of 100 peso in buying the aircon for next month.

2. How is the market interest rate in the short term and long-term financial market affected under
the pure expectations theory when suppliers and users of loanable funds expect that interest
rates will decrease the next year?
o By looking at current long-term interest rates, pure expected theory forecasts short-
term interest rates. If the predicted interest rate falls next year, investors will be
discouraged from supplying more funds due to the low returns earned in the next year,
and more funds will be supplied in the long term. Short-term fund users will be enticed
to borrow more funds because the price is lower and there are fewer long-term
borrowings. Short-term interest rates are lower than long-term interest rates, hence the
yield curve slopes upwards, representing larger returns on longer-term investments.

3. How does the liquidity premium theory influence the market interest rate?
o Liquidity premium is a sort of additional compensation that encourages investors to
engage in high-risk securities that are difficult to convert into cash at fair market value.
The behavior of the yield curve on interest rates for bond investments of various
maturities is determined by the liquidity premium. It claims that short-term securities
have more liquidity since they have a lower risk of losing value on the investment than
long-term assets, which are considered illiquid and have a higher chance of losing value.
The notion can also be applied to the long term, where it provides a liquidity premium
to compensate for the instruments' negative qualities.

4. What are the different factors that affect the interest rates set by issuers of debt securities?
i.
o Credit risk is a method of measuring a borrower's creditworthiness by looking at their
credit score. If the borrower's credit score is poor, they should charge a high interest
rate to compensate for the risk. In the case of a high credit score, they may be able to
provide a low interest rate due to the low risk. As well as for bond-issuing corporations.
Bond ratings are used to evaluate their bonds. Bonds with a good credit rating offer
 cheap interest rates due to their minimal credit risk. To compensate for the significant
credit risk, bonds with low ratings must offer a high interest rate.
o 2nd Liquidity – are securities can be easily converted to cash. Debt securities with short
term has more liquidity compare to long term maturity. It affects the interest rates
where it offers liquidity premium for security has lower liquidity because it can't be sold
quickly enough to prevent or minimize a loss.
o Tax statues- Investors should be mindful of tax reductions and after-tax income,
according to third-tax statutes. When an investor has a little quantity of before-tax
income and is unaware of the tax decrease, he may be surprised to see that his after-tax
income is significantly lower than what he expected in before-tax income. To
compensate for the tax reduction, taxable securities must give a greater before-tax
yield.
o term of maturity -Debt securities have different maturity dates; a short-term bond pays
less interest but provides more flexibility to the investor. The loan will be repaid in a
year or less, and the funds can be re-invested at a higher rate. Long-term bonds provide
greater compensation for the interest rate risk that the investor assumes. Although the
investor is investing for the long term, there is a risk that if interest rates rise, the
investor would miss out on a better rate of return.