Strategic Finance

SUBMITTED TO: Sir Usman Kemal

ASSIGNMENT SUBMITTED BY : Iqbal Hassan DATED: 25th September, 2013

Question: what are the different factors that affect equilibrium of laonable
fund theory?

Answer: equilibrium level could be achieved when demand is equil to supply.

Surplus and shortage conditions. a. Surplus- Quantity demanded < quantity supplied followed by market interest rate decreases. b. Shortage Government interest rate ceilings below market interest rates.

There are following factors that affect equilibrium

1. Economic Growth
o Expected impact is an outward shift in the demand schedule without obvious shift in supply. o Increased growth; increased demand for funds; interest rates increase. o Result is an increase in the equilibrium interest rate.

2. Inflation
o If inflation is expected to increase. o Households may reduce their savings to make purchases before prices rise. o Supply shifts to the left, raising the equilibrium rate. o Also, households and businesses may borrow more to purchase goods before prices increase. o Demand shifts outward, raising the equilibrium rate.

3. Money Supply
o When the Fed increases the money supply, it increases supply of loanable funds. o Places downward pressure on interest rates.

4. Federal Government Budget Deficit

o Increase in deficit increases the quantity of loanable funds demanded o Demand schedule shifts outward, raising rates.. o Government is willing to pay whatever is necessary to borrow funds, crowding out the private sector.

5. Foreign Flows
o In recent years there have been massive flows between countries. o Driven by large institutional investors seeking high returns. o They invest where interest rates are high and currencies are not expected to weaken. o These flows affect the supply of funds available in each country. o Investors seek the highest real after-tax, exchange rate adjusted rate of return around the world.