Chapter 6: Measuring and Calculating Interest Rates and Financial Asset

Prices

1.What is Interest Rate?

The interest rate is the amount a lender charges a borrower and is a percentage of
the principal the amount loaned.

2.Units of Measurements for Interest Rates.

The interest rate is the price charged a borrower for the loan of money. This price
is unique because it is really a ratio of two quantities: the total required fee a
borrower must pay a lender to obtain the use of credit for a stipulated time period
divided by the total amount of credit made available to the borrower. By
convention, the interest rate is usually expressed in percent per annum. Thus,

3. What Are Basis Points (BPS)?

Basis points (BPS) refers to a common unit of measure for interest rates and other
percentages in finance. One basis point is equal to 1/100th of 1%, or 0.01%, or
0.0001, and is used to denote the percentage change in a financial instrument. The
relationship between percentage changes and basis points can be summarized as
follows: 1% change = 100 basis points and 0.01% = 1 basis point.
 1 0.01%
5 0.05%
10 0.1%
50 0.5%
100 1%
1000 10%
10000 100%

Chapter 7: Inflation, Yield Curves, and Duration

4. What is Inflation? Correlation between Inflation and Interest rate.

Definition Inflation: Inflation is the percentage change in the value of the

Wholesale Price Index (WPI) on a year-on year basis. It effectively measures the
change in the prices of a basket of goods and services in a year. In India, inflation
is calculated by taking the WPI as base.

Interest Rate: The interest rate is the amount a lender charges a borrower and is a
percentage of the principal—the amount loaned. The interest rate on a loan is
typically noted on an annual basis known as the annual percentage rate (APR).

Inflation rate signifies the change in the price of goods and services due to
inflation, thus signifying increasing price and increasing demand of various goods
whereas interest rate is the rate charged by lenders to borrowers or issuers of debt
instrument where an increased interest rate reduces the demand for borrowing and
increases demand for investments.

5.What is yield curve? Types of yield curve.

Yield Curve: A yield curve is a line that plots yields (interest rates) of bonds
having equal credit quality but differing maturity dates. The slope of the yield
curve gives an idea of future interest rate changes and economic activity.

Types of Yield Curves

1.Normal Yield Curve: A normal or up-sloped yield curve indicates yields on

longer-term bonds may continue to rise, responding to periods of economic
expansion.

2.Inverted Yield Curve: An inverted yield curve instead slopes downward and
means that short-term interest rates exceed long-term rates.
3.Flat Yield Curve: A flat yield curve is defined by similar yields across all
maturities. A few intermediate maturities may have slightly higher yields, which
causes a slight hump to appear along the flat curve.
Flat Yield Curve: A flat yield curve is defined by similar yields across all maturities.
A few intermediate maturities may have slightly higher yields, which causes a
slight hump to appear along the flat curve.

6.The Unbiased Expectation Hypothesis

The Unbiased Expectations Hypothesis states that the forward interest rates are
unbiased predictors of subsequent spot interest rates.

Chapter 9: Interest Rate Forecasting and Hedging

7.What is interest rate Swaps?

An interest rate swap is a forward contract in which one stream of future interest
payments is exchanged for another based on a specified principal amount.