ROLE OF

INTEREST RATES
IN OUR ECONOMY
INTEREST RATES
The amount a lender charges a borrower and is a percentage of the principal-
The amount loaned.
Simple Interest Formula: P x r x n
where:
P = Principal
r = Interest Rate
n = Term of loan, in years

ROLE OF INTEREST RATES IN OUR ECONOMY

Interest rates are one of the most important numbers in the

economy because they influence how likely people are to borrow
money.
 importance of interest rates
a. Interests control the flow of money in the economy.
b. If interest rates are increasing and the Consumers Price
Index (CPI) is decreasing, this indicates the economy is not
overheating which is good.
c. If rates are increasing and the Gross Domestic Product
(GDP) is decreasing, the economy is decreasing, the
economy is slowing too much which is bad.
d. If rates are decreasing and GDP is increasing, the economy
is speeding up, and that is good.
e. But if the rates are decreasing and the (CPI) is increasing,
the economy is headed towards inflation.
What Is Consumer Price Index (CPI)?
The Consumer Price Index (CPI) - a statistical estimate of the change in prices
for a basket of goods and services purchased by households.

Step 1: Select a base year

Step 2: Select the market basket
Step 3: Record the prices for the items in the market basket
Step 4: Solving
FORMULA:
Value of current market basket
CPI = X 100
Value of market basket in base year
What Is Gross Domestic Product (GDP)?
The total monetary or market value of all the finished goods and services
produced within a country’s borders in a specific time period.
Types of Gross Domestic Product
Nominal GDP
Real GDP
GDP per Capita
GDP Growth Rate
GDP Purchasing Power Parity (PPP)
FORMULA: GDP = C + G + I + NX
where:
C = Consumption spending
G = Government spending
I = Interest
NX = Net exports ( exports - imports)
 What is inflation?
Inflation is a rise in prices, which can be translated as the decline
of purchasing power over time. The rate at which purchasing
power drops can be reflected in the average price increase of a
basket of selected goods and services over some period of time.

What is deflation?
Deflation is a general decline in prices for goods and services,
typically associated with a contraction in the supply of money
and credit in the economy. During deflation, the purchasing
power of currency rises over time.
the role of BSP in determining
interest rates in the economy?
The Bangko Sentral ng Pilipinas (BSP) is
the central bank of the Philippines,
responsible for determining interest rates
and maintaining price stability. Its main
tool is the overnight reverse repurchase
rate, which controls lending and borrowing
costs. Other monetary policy tools, like
the reserve requirement ratio and term
deposit facility, manage liquidity and
influence market interest rates.
a. Economic strength
Measuring the size of a country's economy involves several different key factors, but
the easiest way to determine its strength is to observe its Gross Domestic Product
(GDP), which determines the market value of goods and services produced by a
country.
b. Government policy
Government is a system governing an organized community and government usually
consists of legislature, executive and judiciary. Government policy is a declaration of
government political activities, plans and intentions relating to a particular cause.
c. Supply and demand
Supply is the amount of a specific good or service that's available in the market.
Demand is the amount of the good or service that customers want to buy. Supply and
demand are both influenced by the price of goods and services.
d. Credit risk
Credit risk is the probability of a financial loss resulting from a borrower's failure to
repay a loan. Essentially, credit risk refers to the risk that a lender may not receive
the owed principal and interest, which results in an interruption of cash flows and
increased costs for collection. Lenders can mitigate credit risk by analyzing factors
about a borrower's creditworthiness, such as their current debt load and income.
e. Loan period
A loan period is the amount of time that a borrower will have to repay their loan. It will
be determined by factoring in the minimum and maximum payment, interest rate, and
principal amount. Simply stated—the start of loan repayment, all the way until the
end, is called the loan period.
 a. Annual percentage rate (APR)
An annual percentage rate (APR) represents the total annual cost of borrowing
money, represented as a percentage. Comparing APRs across multiple loans or
lenders can help you find the best options for your situation.

b. Annual percentage yield (APY)

Annual percentage yield is a normalized representation of an interest rate, based on
a compounding period of one year. APY figures allow a reasonable, single-point
comparison of different offerings with varying compounding schedules.
importance of interest rates in the economy
a. Influences consumer and business spending
Interest rates directly affect borrowing costs, with low rates promoting
affordability and spending on housing, cars, and capital investments, while high
rates discourage borrowing and decrease spending.
b. Indicates potential return on investments
Interest rates serve as a benchmark for investors, with higher rates attracting
more risky assets like bonds, while lower rates may encourage riskier
investments.
c. Influence cost of borrowing
Interest rates significantly influence the cost of borrowing money, affecting the
affordability of loans for individuals and businesses, including mortgages, car
loans, and business loans.
 importance of interest rates in the economy
d. Provides insight into future economic and financial market activity
Central banks use interest rates to manage economic conditions, adjusting them
to signal their expectations for growth or cooling an overheating economy.
e. Influences return on savings.
Interest rates directly affect the return on savings and investments for individuals.
Higher interest rates lead to higher earnings for savers on savings accounts, CDs,
and bonds, while lower rates result in lower earnings for investors.
what is the effect of Interest rates on individuals and businessmen?

INDIVIDUALS: Interest rates affect the decisions you make with money. Some of
these are obvious – think about how much more money you would stick in your
savings account if it paid 15% interest instead of 0.5%.

BUSINESSES: When interest rates are rising, both businesses and consumers
will cut back on spending. This will cause earnings to fall and stock prices to
drop. On the other hand, when interest rates have fallen significantly,
consumers and businesses will increase spending, causing stock prices to rise.
RISK
Risk is defined in financial terms as the chance that an outcome or
investment's actual gains will differ from an expected outcome or return.
Risk includes the possibility of losing some or all of an original investment.

RETURN
A return can be expressed nominally as the change in dollar value of an
investment over time. A return can also be expressed as a percentage
derived from the ratio of profit to investment. Returns can also be presented
as net results (after fees, taxes, and inflation) or gross returns that do not
account for anything but the price change.
Risk / Return Relationship
Risk and return are directly related. The greater the risk that an investment
may lose money, the greater its potential for providing a substantial return.
By the same token, the smaller the risk an investment poses, the smaller the
potential return it will provide.

Risk aversion
Risk aversion is the tendency to avoid risk. The term risk-averse describes
the investor who chooses the preservation of capital over the potential for a
higher-than-average return. In investing, risk equals price volatility. A volatile
investment can make you rich or devour your savings. A conservative
investment will grow slowly and steadily over time.
What is an Investment Pyramid?
pyramid of risk:
An investment pyramid, or risk
pyramid, is a portfolio strategy
that allocates assets according
to the relative risk levels of
those investments. The risk of
an investment is defined in this
strategy by the variance of the
investment return, or the
likelihood the investment will
decrease in value to a large
degree.
What Is Financial Risk?
Financial risk is the possibility of losing money on an investment or business
venture. Some more common and distinct financial risks include credit risk,
liquidity risk, and operational risk.

types of financial risk:

a. Systematic Risk
Refers to the risk inherent to the entire market or market segment.
Systematic risk, also known as undiversifiable risk, volatility risk, or market
risk, affects the overall market, not just a particular stock or industry.
types of financial risk:
b. Unsystematic Risk
Refers to risks that are not shared with a wider market or industry.
Unsystematic risks are often specific to an individual company, due to their
management, financial obligations, or location. Unlike systematic risks,
unsystematic risks can be reduced by diversifying one's investments.
c. Country Risk
Refers to the uncertainty associated with investing in a particular country,
and more specifically the degree to which that uncertainty could lead to
losses for investors. This uncertainty can come from any number of factors
including political, economic, exchange-rate, or technological influences.
types of financial risk:
d. Interest Rate Risk
The danger that the value of a bond or other fixed-income investment will
suffer due to a change in interest rates.
e. Credit Risk
The possibility of a loss resulting from a borrower’s failure to repay a loan or
meet contractual obligations.
f. Foreign Exchange Risk
Refers to the losses that an international financial transaction may incur due
to currency fluctuations. Also known as currency risk, FX risk and exchange-
rate risk, it describes the possibility that an investment’s value may decrease
due to changes in the relative value of the involved currencies.
 types of financial risk:
g. Market Risk
Market risk is the possibility that an individual or other entity will experience
losses due to factors that affect the overall performance of investments in
the financial markets.
h. Political Risk
Is the risk an investment's returns could suffer as a result of political
changes or instability in a country. Instability affecting investment returns
could stem from a change in government, legislative bodies, other foreign
policymakers or military control.
What Is Diversification?

Diversification is a risk management strategy that creates a mix

of various investments within a portfolio. A diversified portfolio
contains a mix of distinct asset types and investment vehicles in
an attempt to limit exposure to any single asset or risk.
Owning a wide variety of investment with different
characteristics to reduce volatility.