CHAPTER

INTEREST RATES

Lecturer: Assoc. Prof., Ph.D. DANG VAN DAN

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 CONTENTS
1. DEFINITION AND ESSENCE OF INTEREST RATES

2. ROLES OF INTEREST RATES

3. INTEREST CALCULATION METHOD

4. CLASSIFICATION OF INTEREST RATES

5. DETERMINANTS OF INTEREST RATES

6. IMPACTS OF INTEREST RATES

7. RISK STRUCTURE OF INTEREST RATES

8. TERM STRUCTURE OF INTEREST RATES

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1. DEFINITION AND ESSENCE OF INTEREST RATES:

1.1. DEFINITION:
▪ Interest is the amount of money the borrower pays to the

lender in order to use the loan for a certain period of time.

▪ Interest rate is expressed in percentage, reflecting the

interests (or expenses) charged on the total loan over a

certain period of time.

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1. DEFINITION AND ESSENCE OF INTEREST RATES:

1.2. ESSENCE OF INTEREST RATES:

Interest is the price of credit

Interest is the price of loan capital

Interest rate is the tool to reflects the price of

loan capital.

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2. ROLES OF INTEREST RATES

✓ Interest rate is a tool to stimulate benefits to attract surplus

capital in the economy
✓ Interest rate is a tool to encourage banks and businesses to
operate effectively
✓ Interest rate is one of the tools to forecast the state of the
economy
✓ Interest rate is a tool to regulate macroeconomics
✓ Interest rate is a tool to stimulate investments for the
economic development

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3. INTEREST CALCULATION METHODS

3.1. SIMPLE INTEREST

Original capital C0, interest rate i %, n term, simple interest

Term Original capital Interest
1 C0 A1 = C0.i
2 C0 A2 = C0.i
3 C0 A3 = C0. i
… … …
n C0 An = C0.i 6
3. INTEREST CALCULATION METHODS
3.2. COMPOUND INTEREST

Original capital C0, interest rate i %, n term, compound interest

Total original capital
Term Original capital Interest
and interest
1 C0 A1 = C0.i C1=C0(1 + i)
2 C1 A2 = C1.i C2=C0(1 + i)2
3 C2 A3 = C2.i C3=C0(1 + i)3
… … … …
n Cn-1 An = Cn-1.i Cn=C0(1 + i)n
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4. CLASSIFICATION OF INTEREST RATES

4.1. BASED ON THE VALUE OF INTERESTS

✓ Nominal interest rates
✓ Real interest rates

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4. CLASSIFICATION OF INTEREST RATES

NOMINAL INTEREST RATES

Nominal interest rate

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4. CLASSIFICATION OF INTEREST RATES

REAL INTEREST RATE

FISHER EQUATION

ir = i − Πe

Real interest Nominal interest Inflation expectations

rate rate

FISHER EFFECT

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4. CLASSIFICATION OF INTEREST RATES

4.2. BASED ON CREDIT TERMS

Short-term interest rates Long-term interest rates

US short and long-term bond yields from 2004 to 2005 11

4. CLASSIFICATION OF INTEREST RATES

4.3. BASED ON THE STABILITY OF INTEREST RATES

Fixed rates Floating rates

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4. CLASSIFICATION OF INTEREST RATES

4.4. BASED ON THE METHOD OF INTEREST

PAYMENT
✓ Discount rates
✓ Coupon rates
✓ Accrual rates

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4. CLASSIFICATION OF INTEREST RATES

4.5. BASED ON BANKING ACTIVITIES

− DEPOSIT RATES

− LENDING RATES

− DISCOUNTING RATES

− REDISCOUNTING RATES

− REFINANCING RATES

− INTERBANK OFFERED RATES

− BASE RATES

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4. CLASSIFICATION OF INTEREST RATES

4.5. BASED ON BANKING ACTIVITIES

DEPOSIT RATE

Deposit rates at some banks in 2013 15

4. CLASSIFICATION OF INTEREST RATES

4.5. BASED ON BANKING ACTIVITIES

LENDING RATE

Subjects Short-term Long-term

(VND) Normal business production
9,5 – 11,5% 12 – 13%

(VND) Agriculture, rural areas, export,

small and medium enterprises, supporting
8 – 9% 11 – 12%
industries, enterprises applying high
technology
(USD) 5 – 6% 6,5 – 7%
Lending rates at some banks in 2013 16
4. CLASSIFICATION OF INTEREST RATES

4.5 BASED ON BANKING ACTIVITIES

Financial
Financial Money assets
Money assets
Money

Enterprises
Commercial Central
banks bank

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4. CLASSIFICATION OF INTEREST RATES

4.5 BASED ON BANKING ACTIVITIES

INTERBANK OFFERED RATE

Interbank offered rates in Vietnam on 16/08/2013 18

4. CLASSIFICATION OF INTEREST RATES

4.5 BASED ON BANKING ACTIVITIES

BASE RATE

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5. DETERMINANTS OF INTEREST RATES

5.1. DIRECT DETERMINANTS

▪ Capital demand

▪ Capital supply

5.2. INDIRECT DETERMINANTS

▪ Expected inflation rate

▪ Economic development

▪ Average return rate

▪ Fiscal policy

▪ Monetary policy
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5. DETERMINANTS OF INTEREST RATES

5.1. DIRECT DETERMINANTS

Capital demand captures the entire amount of capital that

the economy needs to borrow.

Capital demand from enterprises

Capital demand from the government

Capital demand from consumers

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5. DETERMINANTS OF INTEREST RATES

5.1. DIRECT DETERMINANTS

Capital supply captures the amount of capital provided to

meet the needs of the economy.

Savings:

Money:

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5. DETERMINANTS OF INTEREST RATES

5.1.DIRECT DETERMINANTS Rate

Equilibrium rate

i*

0 Q* Capital

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5. DETERMINANTS OF INTEREST RATES

5.2. INDIRECT DETERMINANTS

Expected inflation rate

Rate

i*2

i*1

0 Capital
Q*2 Q*1 24
5. DETERMINANTS OF INTEREST RATES

5.2. INDIRECT DETERMINANTS

Economic development

Capital
demand

Capital
supply

Equilibri-
um rate

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5. DETERMINANTS OF INTEREST RATES

5.2. INDIRECT DETERMINANTS

Average return rate

Rate

i*2

i*1

0
Q*1 Q*2 Capital 26
5. DETERMINANTS OF INTEREST RATES

5.2. INDIRECT DETERMINANTS

Fiscal policy

EASY FISCAL POLICY TIGHT FISCAL POLICY

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5. DETERMINANTS OF INTEREST RATES

5.2. INDIRECT DETERMINANTS

Monetary policy
TIGHT MONETARY POLICY EASY MONETARY POLICY

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6. IMPACTS OF INTEREST RATES

6.1. IMPACT ON INVESTMENTS

Interest rates  Investments

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6. IMPACTS OF INTEREST RATES

6.2. IMPACT ON SPENDING

Interest rates 
Spending

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6. IMPACTS OF INTEREST RATES

6.3. IMPACT ON NET EXPORTS

Interest rates  Net exports

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6. IMPACTS OF INTEREST RATES

6.4. IMPACT ON INFLATION

Interest rates  Inflation

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7. RISK STRUCTURE OF INTEREST RATES

7.1. DEFINITION
▪ The risk structure of interest rates is the correlation
related to interest rates between debt instruments with the
same with maturity.
▪ The risk premium is the interest-rate difference between a
risky debt instrument and a risk-free debt instrument,
measuring the additional interest that a lender obtains when
holding a risky debt instrument.

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7. RISK STRUCTURE OF INTEREST RATES
7.2. DETERMINANTS OF THE RISK STRUCTURE OF

INTEREST RATES Credit

risk

Determinants of

the risk

structure of

Tax interest rates

Liquidity
policy

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7. RISK STRUCTURE OF INTEREST RATES

7.2. DETERMINANTS OF THE RISK STRUCTURE OF

INTEREST RATES
▪ Credit risk occurs when a borrower is incapable of

performing a debt obligation (repayment of principal,

interest, or both) to the lender on the due date. This is a

characteristic of debt instruments in the credit market,

strongly influencing interest rates.

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7. RISK STRUCTURE OF INTEREST RATES

7.2. DETERMINANTS OF THE RISK STRUCTURE OF

INTEREST RATES

Liquidity refers to the ease with which an asset can be

converted into ready cash without affecting its market price.

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7. RISK STRUCTURE OF INTEREST RATES

7.2. DETERMINANTS OF THE RISK STRUCTURE OF

INTEREST RATES

Tax is levied on the interest income from a debt instrument.

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 RISK PREMIUM

(i) (i)

D S

D
S
ie e

o
io

(C) (C)
1 2 38
8. TERM STRUCTURE OF INTEREST RATES

8.1. DEFINITION
▪ Term structure of interest rates is the correlation related
to interest rates between debt instruments with the same
characteristics of credit risk, liquidity, and tax, but differ in
the term of payment.

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8. TERM STRUCTURE OF INTEREST RATES

8.1. DEFINITION
(1) Upward slope

Rate

Term
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8. TERM STRUCTURE OF INTEREST RATES

8.1. DEFINITION:
(2) Horizontal slope

Rate

Term
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8. TERM STRUCTURE OF INTEREST RATES

8.1. DEFINITION:
(3) Downward slope

Rate

Term
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8. TERM STRUCTURE OF INTEREST RATES

8.1. DEFINITION
(4) Hump slope

Rate

Term 43
8. TERM STRUCTURE OF INTEREST RATES

8.2. THEORY OF EXPECTATION

▪ Debt instruments with the same risk of default, liquidity, tax

but different maturity will be considered equivalent if they

have the same expected returns.

▪ If debt instruments have different maturities but can be

perfectly substituted, then the interest rate of the n-period-

term instrument is equal to the average of the one-period-

term instruments.

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8. TERM STRUCTURE OF INTEREST RATES

8.2. THEORY OF EXPECTATION

Formation:
n

i t
i(n) = t =1
n

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8. TERM STRUCTURE OF INTEREST RATES

8.2. THEORY OF EXPECTATION

(*) Notes:

Advantages

Disadvantages

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8. TERM STRUCTURE OF INTEREST RATES
8.3. SEGMENTED MARKETS THEORY
Opinions
Debt instruments with different maturity levels are
completely separate and irreplaceable.

The interest rate of a debt instrument is determined by

the supply and demand for that instrument, not by the
interest rate of other maturity instruments.

Investors prefer short-term investments over long-term ones

→ The interest rate for the short-term debt instrument is
usually lower than the interest rate for the long-term one. 47
8. TERM STRUCTURE OF INTEREST RATES

8.4. PREFERRED HABITAT THEORY

✓ Debt instruments with different maturity levels are
interchangeable, but not perfectly interchangeable.
✓ Investors often prefer short-term debt instruments over
long-term debt ones. This preference is known as the
“prioritized environment”.
✓ Formula: n

i t
i (n) = t =1
+ k (n)
n

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8. TERM STRUCTURE OF INTEREST RATES

8.4. PREFERRED HABITAT THEORY

Notes:

The following issues can be explained:

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