Understanding the difference between key economic terms

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Monetary policy vs fiscal policy; Treasury bills vs treasury bonds vs treasury notes; and yield vs interest rates

The below article is in continuation with our previous article where we covered difference between commonly confused terms such as Common stock vs Preferred stock; Recession vs Depression; and NEFT vs RTGS.

In the following article we will cover the difference between important economic terms such as Monetary policy vs fiscal policy; Treasury bills vs treasury bonds vs treasury notes; and yield vs interest rates.

MONETARY AND FISCAL POLICY

Every government establishes some policy objectives for the purpose of stabilizing the business cycle and reducing the problems of poverty, unemployment, inflation, basically for the economic development of the economy.

Monetary Policy is a term used to refer to the actions of central banks to achieve macroeconomic policy objectives such as price stability, full employment, and stable economic growth. It is basically, controlling the quantity of money in circulation for the achievement of these objectives.  Thus, The Federal System acts as an independent agency and it is free from any political influence.

Fiscal policy is a broad term used to refer to the tax and spending policies of the federal government. The decisions are determined by the government and the Federal System plays no role here. The statutory objectives of this policy are maximum employment and price stability. It mainly targets the interest rate of the banks, purchasing long-term securities and government spending. Thus, basically it controls the aggregate demand and supply in the goods market.

 

TREASURY BILLS, TREASURY NOTES, TREASURY BONDS

When it comes to government bonds, treasury bills, notes and bonds are the most common things one hears of. These securities are generally issued by the government to fund its debts, and are all backed up with the full faith and credit of the government. Basically all these three securities are the same, however the two key differences between them is that of their maturity date and the way they pay their interest.

Treasury bills (“T-bills”) are short-term bonds that mature within one year or less from their time of issuance. They are sold with maturities of one, three, six and twelve months. The one, three, six months bills are auctioned once a week whereas the twelve months bills are auctioned in every four weeks. Since, their maturity period is so short, they offer lower yield as compared to Treasury notes and Bonds. However, they experience very little in the way of price fluctuation since they mature in such a short amount of time.

Treasury Notes are medium-termed bonds and are issued with maturities of one, three, five, seven, and ten years. The ten year bond is the most widely followed of all maturities. Treasury bonds (also called “long bonds”) offer maturities of 20 and 30 years. The only difference between these two is the maturity period. Also, once T-notes and T-bonds are issued, their prices fluctuate so their yields remain linked to market prices. In general, the longer the time there is until the bond matures, the greater price fluctuation it will experience.

 

YIELD AND INTEREST RATE

Yields and interest rate basically refers to earnings on investments or deposits however are two different terms. The main difference between these terms, yields and interest rate is that each of these terms refers to different financial instruments. Yield commonly refers to the dividend, interest or return the investor receives from a security like a stock or bond, and is usually reported as an annual figure. Interest rate generally refers to the interest charged by a lender such as a bank on a loan, and is typically expressed as an annual percentage rate (APR).

The percentage of yield can fluctuate and depends on the stock price or bond price. For example , if PepsiCo pays a quarterly dividend of 50 cents and the stock price is $50, then the annual dividend yield would be 4% [(50 cents x 4 quarters) / ($50)x100]. Therefore the current yield is 4%. If the stock price increases to $100 and the dividend remains the same, then the yield becomes 2% and if the stock price reduces to $25 and dividend remains the same, then the yield will become 8%.

On the contrary, simple interest rate is a fixed percentage on the principal whereas with Compound Interest, you work out the interest for the first period, add it to the total, and then calculate the interest for the next period, and so on. For eg: If you borrow 1000$ from bank and interest rate is 5 % then the interest will be 50$ (1000×0.05…Simple interest). If the interest rate is compounded then it will be a bit more from the following years.

 

About the Author:

Vipul Falor is a management student at NMIMS University, Mumbai. He is passionate about financial markets and is always enthusiastic about learning more in the financial markets.