INTEREST RATE, ITS LEVEL, STRUCTURE AND ISSUES

Presented by:Rupesh nayaupaneMBA Apex college

BACKGROUND• Interest-the cost of borrowing • interest rate-the rate expressed as a percentage of the total sum

borrowed for a stated period of time.• Regulated by Central bank during the early stage of financial

market development(1955 to 1965).• But, the country's central bank namely Nepal Rastra Bank

gradually began to liberalize.• In early mid 1980’s- country’s economic policy liberalized CB

guides BFIs.• Basically determined by demand and supply of funds.

STRUCTURE AND ITS LEVEL DEPENDS ON:

• the behavior of the yield curve• composition of the maturity structure• sensitivity of the change in the interest rate, and,

default risk included in matching the level of interest rate and its relationship with the yield

curve.

THE FIVE COMPONENTS OF INTEREST RATES

1. Real Risk-Free Rate 2. Expected Inflation 3. Default-Risk Premium 4. Liquidity Premium5. Maturity Premium 

REAL VS NOMINAL INTEREST RATES• The nominal interest rate is the amount, in percentage terms,

of interest payable.• The real interest rate, which measures the purchasing power

 of interest receipts, is calculated by adjusting the nominal rate charged to take inflation into account.

• Nominal interest rate =Real interest rate+inflation.

SPREAD RATE AND BASE RATE

• The spread of interest rates=lending rate - deposit rate.• This covers operating costs for banks providing loans and

deposits. A negative spread is where a deposit rate is higher than the lending rate

• The base rate is lowest rate at which a bank will charge interest, also known as the repo rate. The rate is set by the monetary policy with a view to controlling inflation over the medium-term.

• Banks usually charge interest at a stipulated figure 'above base rate'. If the base rate rises, then usually the rate of interest charged on the loan will rise to preserve the differential. If it falls, so will the rate on the loan.

2013 2014 2015July 9.83Dec 8.86Jan 8.75 7.49Feb 8.58 7.51March 8.55 7.52Aprl 8.38May 8.31Jun 8.23Jul 8.36Aug 7.68Sep 7.90Oct 7.73Nov 7.76Dec 7.44

INTEREST RATE STRUCTURE IN NEPALIn Nepal, interest rates decisions are taken by the Nepal Rastra Bank. The official interest rate is the bank rate.Types/year 2002 2004 2005 2006 2007 2015

T-bills 4.94 3.81 4.79 4.04 2.13 1.3759Deposit 2-7.5 2-6 1.5-6.05 1.5-6.4 1.5-5.5 3.79(Wtg)

Lending 4-16 4-14.5 4-14.5 5-13.5 5-13.5 9.56(Wtg)

Standing liquidity facility

- - 1.5 1.5 1.5 8

Nepal Money Last Highest Lowest

Interest Rate 7.00 8.00 5.50

Interbank Rate 1.01 12.83 0.15(2014.

Aug/Dec, 2015 Jan)

Till date:

REASONS FOR INTEREST RATE CHANGES

• Political short-term gain• Deferred consumption• Inflationary expectations• Alternative investments• Risks of investment• Liquidity preference• Taxes• Banks• Economy

 THE EFFECT OF MARKET INTEREST RATES ON BOND PRICES AND YIELD

Lower market interest rates higher fixed-rate bond prices lower fixed-rate bond yields

Financial Term Today One Year Later ↓

Market Interest Rate 3% 2%

Coupon Rate (semi-annual

payments)

3% 3%

Face Value $1,000 $1,000

Maturity 10 years 9 years remaining

Price $1,000 $1,082

Yield to Maturity 3% 2%

ISSUES:• Elasticity of substitution• Output and unemployment• Excess liquidity• Money and inflation

RELATIONSHIP BETWEEN INFLATION AND INTEREST RATESInterest rates, more people are able to borrow more money. The result is that consumers have more money to spend, causing the economy to grow and inflation to increase. The opposite holds true for rising interest rates. As interest rates are increased, consumers tend to have less money to spend. With less spending, the economy slows and inflation decreases. Interest rates affect the rise & fall of inflation?Like in demand-pull theory, Lower interest rates put more borrowing power in the hands of consumers. And when consumers spend more, the economy grows, naturally creating inflation.If the central bank decides that the economy is growing too fast (which is a bad sign in the long term), They will try to minimize the effect of it by increasing the interest rates and vice versa, this rising interest rates in turn will encourage people to save more and borrow less thus reducing the amount of money in circulation in the market. Lesser money in the market makes it difficult to buy the goods and services thus slowing down the rise in price.In short, stable economy is a healthy economy with right wages and less unemployment.

INFLATION IN NEPAL

The inflation rate in Nepal was recorded at 10.40 percent in November of 2015. Inflation Rate in Nepal averaged 8.36 percent from 1964 until 2015, reaching an all time high of 30.42 percent in May of 1966 and a record low of -11.54 percent in May of 1967. Inflation Rate in Nepal is reported by the Nepal Rastra Bank.

Actual Previous Highest Lowest Dates Unit Frequency

10.40

(Nov

2015)

8.30 30.42

(May

1966)

-11.54

(May

1967)

1964 -

2015

percent Monthly

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