Unit 3 Lesson Plan

 

Lesson 3: What is the FED? How do they control Interest Rates?

Lesson Objectives

Lesson Objective 1: What is the FED

Lesson Objective 2: What is the Mission of the FED

Lesson Objective 3: How does the FED change market conditions with interest rates.

Lesson Objective 4: What does the FED tell us about Mr. Market.

Summary of this Lesson

The FED is short for the U.S. Federal Reserve. The mission of the FED is to care for the U.S. economy. They do this through four different objectives. First they try to ensure maximum employment through price stabilization. Second, they supervise and regulate banks. Third, they maintain stability of the financial system by adjusting interest rates. Fourth, they service the debt obligations for the federal government.

In this lesson, we really focused on the third objective: Maintaining stability of the financial system. In order for the FED to stabilize the economy, they have to constantly adjust the interest rate at which banks can lend money to citizens and businesses. By doing this, the FED is ultimately controlling the spending habits of the U.S. economy. When the FED controls interest rates, it provides predictable investment opportunities for value based investors because they are able to capitalize on the changing market prices of stocks and bonds.

We learned that when interest rates are high, we'll want to focus our efforts on finding quality bonds. By taking this strategy, a value investor can collect high paying coupons and also prepare themselves for a profitable venture when interest rates decrease. Since the value of a bond increases when interest rates decrease, the market value will undoubtedly increase on a long term bond when market crashes force the FED to drop interest rates.

We also learned that when interest rates are low, it's probably a good time to find undervalued stocks. The most lucrative time to buy stocks is during a recession because scared investors are selling their shares at a discount price. Smart investors need to ensure that they always avoid buying companies with marginal levels of debt. In course two, this site conducts a thorough review of all the information you need to properly assess the intrinsic value of stocks and bonds. The key point to take away is that when interest rates are low, you want to ensure that you're buying stocks.

In the end, we learned that the FED actually provides great clues as to the position of Mr. Market. We know that when interest rates are high, the stock market is experiencing a greed cycle. Likewise, when interest rates are low, the stock market is experiencing a fear cycle. This information proves very valuable as value investors capitalize on market movements and opportunities.

Lesson 3 Practical Exercise Video

Be sure to watch this video on the creation of money and more information on fractional reserve banking. The video is quite long, but it will drastically increase your understanding and perspective on banking and the FEDs ability to control our economy. (click anywhere on this text to access the video)

Take a Review Test

Think you know everything from Course1? Test your knowledge by clicking on the link below.

Take Test - When prompted for a password, enter: buffettsbooks

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  • C1 U3 L1
  • Stock Market

    Stock Market

    This is a virtual or physical place where people can purchase or sell ownership of business with cash. Since companies are divided into pieces or shares, investors can go to a stock market to purchase or sell 1 share or millions of shares. A stock market is a place where business owners can go to trade their ownership of a business for money.

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  • Stop Order

    Stop Order

    A stop order, also referred to as a stop-loss order, is an order to buy or sell a stock once the price of the stock reaches a specified price, known as the stop price. When the stop price is reached, a stop order becomes a market order. A buy stop order is entered at a stop price above the current market price. Investors generally use a buy stop order to limit a loss or to protect a profit on a stock that they have sold short. A sell stop order is entered at a stop price below the current market price. Investors generally use a sell stop order to limit a loss or to protect a profit on a stock that they own.

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  • Limit Order

    Limit Order

    A limit order is an order to buy or sell a stock at a specific price or better. A buy limit order can only be executed at the limit price or lower, and a sell limit order can only be executed at the limit price or higher. A limit order is not guaranteed to execute. A limit order can only be filled if the stock's market price reaches the limit price. While limit orders do not guarantee execution, they help ensure that an investor does not pay more than a pre-determined price for a stock.

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  • Mr. Market

    Mr. Market

    This was a metaphor created by Warren Buffett's college professor, Benjamin Graham. Graham used Mr. Market to show students that some days the market will offer great deals and other days, the market will offer horrible prices. Graham described Mr. Market as a disgruntled and opinionated business partner. In the end, Buffett says investors need to make Mr. Market their servant and not their guide.

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  • C1 U3 L2
  • C1 U3 L3
  • FED

    FED

    Short for the United States Federal Reserve

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  • Interest Rates

    Interest Rates

    The percent of money that will be owed to a lender for money that is borrowed.

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