Interest Rates 101

There are lots of different interest rates that you will hear about and see published. It is important for you to know that not all interest rates are for the same things.

Many, including the Fed Funds rate, LIBOR and the Prime rate are actually short term rates. While they may move in a similar direction to other rates, including mortgage rates, they really have very little to do with them. Mortgage rates are determined largely by the sale of mortgage backed securities or MBS. These reflect long term rates which are largely influenced by long term events. Treasury securities and municipal bonds are also generally long term in nature. When the bond market improves that means the fixed rate securities can be sold for a higher price, which results in lower interest rates. When the price goes up the rate goes down as a matter of mathematical calculation. The rate and the price move in opposite directions. The change in price is usually expressed in basis points or in 32nds. Since bonds, treasury securities, and MBS investments are generally viewed as stable and secure their value generally foes up when investors bail out of other more risky investments. However, since they are long term rates inflation generally decrease their value because the more inflation is in the economy the more interest has to be earned just to keep up with it. That why when the economy starts to heat up interest rates tend to go up as well if there is any hint of inflation. Also these investments compete with other investments for available capital. So if the stock market is bullish rates will generally increase so as to compete more favorably with the return on these other investments. Rates are also affected by government action, most notably that of the Federal Reserve. Often the Fed Chairman has been one of the most listened to-and feared-men in the business world. If you want to read more let me know and I’ll find you some good reading material. If you are an investment specialist and care to enlighten our audience more please post your comments.

Any questions?

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