Money and Banking 4

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Determining Interest Rates

Expected return

The return on an asset during a future period; also known as expected rate of return

Risk

The degree of uncertainty in the return on an asset

Diversification

Dividing wealth among many different assets to reduce risk

Market (or systematic) risk

Risk that is common to all assets of a certain type, such as the increases and decreases in stocks resulting from the business cycle

Idiosyncratic (or unsystematic) risk

Risk that pertains to a particular asset rather than to the market as a whole, tas when the price of a particular firm's stock fluctuates because of the success or failure of a new product

Fisher effect

The assertation by Irving Fisher that the nominal interest rises or falls point-for-point with changes in the expected inflation rate

Closed economy

An economy in which households, firms, and governments do not borrow or lend internationally

Open economy

An economy in which households, firms, and governments borrow and lend internationally

Small open economy

An economy in which total saving is too small to affect the world real interest rate

Large open economy

An economy in which shifts in domestic saving and investment are large enough to affect the world real interest rate

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