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Interest Rates Structure, Determinants, Development of BLR and Its Computation

This document discusses interest rates, including definitions, methods of calculating interest, and factors that influence interest rates. It covers nominal vs real rates, simple interest calculation formulas, fixed vs variable rates, annual percentage rates, the determination and calculation of base lending rates, and how inflation, risk, liquidity, bond provisions, and maturity affect interest rates.

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52 views21 pages

Interest Rates Structure, Determinants, Development of BLR and Its Computation

This document discusses interest rates, including definitions, methods of calculating interest, and factors that influence interest rates. It covers nominal vs real rates, simple interest calculation formulas, fixed vs variable rates, annual percentage rates, the determination and calculation of base lending rates, and how inflation, risk, liquidity, bond provisions, and maturity affect interest rates.

Uploaded by

hanimuda
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PPT, PDF, TXT or read online on Scribd
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Interest Rates Structure,

determinants, development of BLR


and its computation
Definition:
a) the price of borrowing money
b) amount charged by lender to borrower for
borrowing a sum of money expressed as percentage
of sum borrowed
 To a lender (surplus unit) – the return earned for
parting with his funds over a certain period of time
 To a borrower (deficit unit) – the price to pay over a
specific period of time (the interest expense)
 Nominal rate is the rate offered and quoted
to customers without taking into account the
inflation rate
 Real rate is the rate after considering inflation
rate
Simple/Approximate formula:
 Real Int. rate = Nominal Int. rate – Inflation rate
(NR) (IR)

Exact Formula:
 Real interest rate = 1 + NR - 1
1 + IR
 Simple Interest rates = pxrxn
365x100

where p = principal amount


r = nominal interest rate
n = no. of days
a. Describe the methods of calculating the
interest – example simple interest;
b. Describe the behavior of interest rate –
example fixed rate or variable rate (pegged
with BLR or KLIBOR)
c. Annual Percentage rate (APR)
 Quotation based on applying an interest rate
to the daily loan balance outstanding during a
specified period;
 Quoted in terms of annual rate (eg. 12 %) or
daily periodic rate (eg. 0.032877)
 Fixed rate - only one interest rate quoted
through out the life of the loan
 Same monthly payment
 It is used because of stable income of
customers and easy to budget
 However exposed banks to interest rate risk,
therefore use variable rate; how?
 Variable rate or floating rates are rates pegged
against BLR, KLIBOR or multi-tiered rates
 Rates changes with the pegged rates
 Protect both borrower and lender against
fluctuations
 Eg. When BLR increases, rates on variable loan
increases and is reflected in higher monthly
payments or increase in number of payment
 Minimises interest rate risk but may increase credit
and collateral risk; how?
 Sometimes banks quote both fixed and variable on
a particular loan
 Gap between fixed and variable increases when
interest rates rise and narrow when rates drop
 Fixed rates  credit cards, car loan or other hire
purchase
 Variable rates  property-based lending and
business loans
 Total cost of borrowing expressed as a percentage; common language to
describe cost of borrowing
 Formula : 2NF (300C + NF)
2

2N F + 300C (N + 1)
Where N = number of instalments
C = no. of instalments to be paid in one year
F = amount determined by 100C x T
NxA
where T = total amount of predetermined term charges
N = no. of instalments
A = amount financed
 BLR is a rate used by commercial banks and finance
companies as a basis to quote for lending and
advances facilities offered to customers
 Generally, it is derived by taking into account the
funding cost. administrative cost and an imputed
profit margin
 Previously, the funding cost is represented by the 3-month
KLIBOR average
 later in 1998 in view of the economic situation the formula
was revised to be based on ‘intervention rate’
 Old framework (for commercial bank):
BLR = (Average KLIBOR* x 0.8) + 2.5%
1 – SRR
* Intervention replaced KLIBOR in 1998
 Currently each bank calculate its own BLR based on cost
structure and business strategies after considering the OPR
(more efficient pricing)
 any changes in OPR will give impact to the level of BLR of
banks
 BLR is based on Overnight Policy Rate (OPR) which
in turn is based on interbank rate
 Thus, OPR is the primary reference rate in
determining other market rates
Interbank rates OPR

BLR
Lending rates
(Rates quoted to customers housing
loan/automobile loan/business loan)
 Higher actual or expected inflation, higher
will be the level of interest rates (positive
relationship)
 Investor needs to earn higher return to
compensate for the increased cost of
foregoing consumption of goods/services
today and buy more highly priced of these
goods/services in the future
 The rate that would exist on a security
without any expected inflation over the
holding period
 It is the percentage change in the buying
power of a dollar
 It measures consumer’s relative time
preference for consuming today rather than
later ; the higher the preference to consume
today the higher will be the real interest rate
 The risk that the issuer will not pay the
interest and principal on a timely basis
 default risk the interest rate demanded
by investor to compensate for the risk
exposure
 The risk that the securities will be easily sold
at the expected price (without reduction in
value)
 Highly liquid assets carries lowest interest
rates
 For Illiquid assets, investors will add a
liquidity risk premium
 Special provisions or covenants in the contract
of an issuance of a security will effect interest
rates; examples callability, convertibility,
taxability
 Thus, if the bond is tax free, the interest rate of
that bond is lower compared to a taxable bond
 Provisions such taxability and convertibility
leads to a lower rates; but if provisions is to the
benefit to the issuer such as callability the
interest rates will bi higher
 Refers to the length of time the security will
mature and this affect interest rates  the ‘term
structure of interest rates’ or ‘yield curve’
 The change in required interest rates as maturity
changes is called ‘maturity premium’
 The ‘maturity premium’ can be positive (an
upward sloping yield curve), negative
(downward sloping curve) or zero ( a flat yield
curve)

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