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Determinants of interest rate

Term paper on

Determinants of Interest Rate Subject Code: ECO(302) Term paper on: Determinants of interest rate

Submitted to: Lutfur Rahaman Lecturer Eastern University

Submitted by: Amit Hasan ……….....ID: 103200081

Program: BBA Section: 03 Date of Submission: 4th Sept, 201

Executive Summary: Interest rates targets are also a vital tool of monetary policy and are taken into account when dealing with variables like investment, inflation, and unemployment. In our report we try to emphasize on the ratio of interest rate and the determinants factors of interest rate because of which the interest rate is fluctuating in Bangladesh. Interest rate is applicable on all type of lending all over the world. Interest rates can be determined by many factors but here we will consider six factors as the determinants of interest rate. These six factors are Gross Domestic Product (GDP), Consumer Price Index (CPI), Budget Deficit, Money Supply, Remittance and Foreign Direct Investment (FDI). In this report we will try to find out how these factors affect the weighted average rate of interest on commercial lending and the relationships between each of the factors and the interest rate. To find the effect of the factors on interest rate we will analyze the regression equation and to find the relationship we will analyze the correlation matrix. To meet this report we use a pool of data in 1991-2011. We get these data from different article as well as some books like Economic Trends published by Bangladesh Bank, Economic Review published by Finance Ministry of Bangladesh Government. Our goal is to find out the effect and relationship between interest rate with the determinants factors like GDP, CPI etc.

Introduction: An interest rate is the rate at which interest is paid by a borrower for the use of money that they borrow from a lender. But high interest rate is causing hinders in business. Because it hamper the enrichment of any sort of business cause of its high interest rate is seems like burden. Interest rates targets are also a vital tool of monetary policy and are taken into account when dealing with variables like investment, inflation, and unemployment. So that central bank always tries to keep interest rate in moderate situation. On other hand interest rate is dominated by some factors like Gross Domestic Product (GDP), Consumer Price Index (CPI), Budget Deficit, Money Supply, Remittance and Foreign Direct Investment (FDI). Here we go with those factors and show its effect on interest rate.

Literature Review Recent paper finds that determinate variables have an impact over interest rate. Like “The daily star”, “The Bangladesh observer”. We also take help from article “Interest rate convergence” by Dewan Mustafizur Rahaman, staff member in study of finance, Dhaka University. Also”Interest Rate Spread and Its Determinants in Bangladesh” by Monzur Hossain, PhD, Bangladesh Institute of Development Studies (BIDS).

Objective:

Primary objective The main objective of the study is to know how those factors affect interest rate.

Secondary objective Relationships between each of the factors and the interest rate. How much interest rate is fluctuated because of those factors? To know about the dominated factors. To know about the interest rate of Bangladesh.

Methodology We use secondary data to conduct this study.

Sources of data Article Books Website etc.

Interest rate and its determinants

Year	interest rate	GDP	Inflation	Money Sppply	Remittances	Budget Dificit	Per Capital Income 1991	 8.74	 5.61	8.285	                   5.3           4.5211	                  7.5	 2.477121255 1992	  11.68	        5.08	3.624	            5.4	4.5679	8.1	2.505149978 1993	  14.67	        4.48	2.979	            5.5	4.6390	5.9	2.505149978 1994	  10.34	        4.6	6.15	            5.6	4.6825	5.6	2.505149978 1995	  6.2	        4.86	10.117	            5.6	4.6964	6.5	2.51851394 1996	  9.37	        4.95	2.455	            5.7	4.7993	6.4	2.544068044 1997	  10.58	        5.12	4.959	            5.7	4.8410	7.7	2.556302501 1998	  8.29	        4.24	8.648	            5.7	4.9137	6.1	2.556302501 1999	  9.05	        5.2	6.179	            5.8	4.9915	5.4	2.568201724 2000	  13.39	        5.3	2.483	 2001	  14.03	        5.6	1.908	5.9	5.1577	4.3	2.579783597 2002	  12.41	        4.4	3.719	6	5.2487	3.7	2.579783597 2003	  10.98	        5.3	5.361	6.1	5.2982	2.4	2.602059991 2004	  10.08	        4.9	6.103	6.1	5.3738	3.3	2.643452676 2005	  8.49	        6.4	7.04	6.2	5.5089	4.3	2.681241237 2006	  9.66	        6.6	6.77	6.3	5.6159	4.4	2.698970004 2007	  8.63	        6.3	9.109	6.3	5.7348	7.6	2.716003344 2008	  6.97	        4.9	8.9	6.4	5.8240	5.3	2.755874856 2009	  7.58	        5.7	5.426	6.5	5.8809	6.3	2.806179974 2010	  6.13	        6	8.126	4.5	5.9190	6.6	2.84509804 2011	  5.34	        6.3	10.7	5.7	6.0478	6.7	2.943494516

Standard Error	1.337913405 Observations	21 ANOVA df	SS	MS	F	Significance F Regression	6	108.1839519	18.03066	10.07292	0.000209288 Residual	14	25.06017192	1.790012 Total	20	133.2441238 Coefficients	Standard Error	t Stat	P-value	Lower 95%	Upper 95%	Lower 95.0%	Upper 95.0% Intercept	37.38736424	17.66111892	2.116931	0.052656	-0.491968395	75.266697	-0.491968395	75.26669688 X Variable 1	0.210210379	0.567577093	0.370364	0.716654	-1.007121412	1.4275422	-1.007121412	1.427542169 X Variable 2	-0.676962749	0.136313404	-4.96622	0.000207	-0.969325923	-0.3846	-0.969325923	-0.384599575 X Variable 3	-0.060439056	0.891747479	-0.06778	0.946922	-1.973047172	1.8521691	-1.973047172	1.85216906 X Variable 4	1.519235464	3.239662551	0.468949	0.646325	-5.429149628	8.4676206	-5.429149628	8.467620556 X Variable 5	-0.169511821	0.26919461	-0.6297	0.539032	-0.746876835	0.4078532	-0.746876835	0.407853193 X Variable 6	-11.91318321	11.89502944	-1.00153	0.33357	-37.42548392	13.599117	-37.42548392	13.5991175 Regression Output Regression Module

Because of we find one dependent variable and multiple variables in this data set, so we have to use multiple regression module here. Module Y= a+b1x1+b2x2+b3x3+b4x4+b5x5+b6x6 Y= interest rate X1= GDP X2= CPI X3= Money Supply X4= Remittance X5= Budget Deficit X6= Per Capita Income ∑= White Noise Error Term

Interpretation of regression equation •	In terms of X variable 1 Coefficients	Standard Error	t Stat	P-value Intercept	37.38736424	17.66111892	2.116931	0.052656 X Variable 1	0.210210379	0.567577093	0.370364	0.716654

Result: We can interpret it by this way that we interpreted the two way variables regression. Here we can see that, if variable (x1) is changed by 1% than the intercept (Y) will change 0.2%. T-Stat is 0.38 and independent variable will not significantly affecting the dependent variable. •	In terms of X variable 2 Coefficients	Standard Error	t Stat	P-value Intercept	37.38736424	17.66111892	2.116931	0.052656 X Variable 2	-0.676962749	0.136313404	-4.96622	0.000207

Result: We can interpret it by this way that we interpreted the two way variables regression. Here we can see that, if variable (x2) is changed by 1% than the intercept (Y) will change –0.6%. T-Stat is -4.9 and independent variable will not significantly affecting the dependent variable.

•	In terms of X variable 3 Coefficients	Standard Error	t Stat	P-value Intercept	37.38736424	17.66111892	2.116931	0.052656 X Variable 3	-0.060439056	0.891747479	-0.06778	0.946922

Result: We can interpret it by this way that we interpreted the two way variables regression. Here we can see that, if variable (x3) is changed by 1% than the intercept (Y) will change –0.06%. T-Stat is -0.06 and independent variable will not significantly affecting the dependent variable. •	In terms of X variable 4 Coefficients	Standard Error	t Stat	P-value Intercept	37.38736424	17.66111892	2.116931	0.052656 X Variable 4	1.519235464	3.239662551	0.468949	0.646325

Result: We can interpret it by this way that we interpreted the two way variables regression. Here we can see that, if variable (x4) is changed by 1% than the intercept (Y) will change 1.5%. T-Stat is 0.4 and independent variable will not significantly affecting the dependent variable.

•	In terms of X variable 5 Coefficients	Standard Error	t Stat	P-value Intercept	37.38736424	17.66111892	2.116931	0.052656 X Variable 5	-0.169511821	0.26919461	-0.6297	0.539032

Result: We can interpret it by this way that we interpreted the two way variables regression. Here we can see that, if variable (x5) is changed by 1% than the intercept (Y) will change -0.16%. T-Stat is -0.6 and independent variable will not significantly affecting the dependent variable.

•	In terms of X variable 6 Coefficients	Standard Error	t Stat	P-value Intercept	37.38736424	17.66111892	2.116931	0.052656 X Variable 6	-11.91318321	11.89502944	-1.00153	0.33357

Result: We can interpret it by this way that we interpreted the two way variables regression. Here we can see that, if variable (x6) is changed by 1% than the intercept (Y) will change -11%. T-Stat is -1 and independent variable will not significantly affecting the dependent variable. Decision: Standard Error	1.337913405 Observations	21 ANOVA df	SS	MS	F	Significance F	Regression	6	108.1839519	18.03066	10.07292	0.000209288 Residual	14	25.06017192	1.790012 Total	20	133.2441238

Here, Significance F is 0.000209288. So it can be said that overall module is not fit.

Limitations

While we conducting our study, some limitations were yet present there: Because of time shortage many related area can’t be focused in depth. Website in different organization of Bangladesh contains poor information. Recent data and information on different factors was unavailable. Data was so much spread. In some extent we use approximate value.

Conclusion: The aim of the paper was to find out the effect of Gross Domestic Product (GDP), Consumer Price Index (CPI), Budget Deficit, Money Supply, Remittance and Foreign Direct Investment (FDI) in interest rate. Now the result seems to conclude that although those variables have some impact over interest rate but there have some other variables those are also influenced interest rate sharply.

Reference:

www.wikipedia.com http://en.wikipedia.org/w/index.php?title=Special%3ASearch&profile=default&search=purpose+of+T-statistic&fulltext=Search http://en.wikipedia.org/wiki/Interest_rate http://www.statsoft.com/textbook/multiple-regression/ www.thedailystar.net/ en.wikipedia.org/wiki/The_Bangladesh_Observer www.bangladeshdir.com/.../bangladesh___ministry_of_finance.html www.bangladesh-bank.org/

Bibliography

“Economic Trends” published by Bangladesh Bank “Economic Review” published by Finance Ministry of Bangladesh     Government

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