Interest rates, Financial Management

Assignment Help:

Interest Rates

The payment borrowers make for the use of the funds that they borrow and the payment that lenders demand for the use of the funds they lend (termed interest) which is expressed as a percentage of the principal (loan amount). This percentage is known as interest rate. Interest rates typically are expressed in overall percentages and basis points. A basis point is one hundredth of a percentage point. There are basically four main parts to market interest rates:

  • The risk (or default) premium
  • The maturity premium
  • An inflation premium
  • The "real" rate

The risk premium is identifying that several classes of borrowers have greater or lesser risk by default. Interest rates are higher for riskier borrowers because they are lowest for the U.S. Treasury, which is considered as a "risk-free" borrower.  The difference in interest rate among any other borrower and the U.S. Treasury for the similar maturity is called a quality spread.  The maturity premium reflects the fact that, in general, a longer loan will have a higher interest rate compare to a shorter loan of the similar quality. The yield curve shows the change in interest rates as maturities are extended for a given class of loans. The inflation premium is identifying that inflation may erode the purchasing power of the funds lent. Therefore, interest includes compensation for the inflation expected over the length of the loan. The remaining part of interest rates reflects the real rate of interest that must be paid to induce the lender to forego the use of the funds. (Note that this is not simply the interest rate less present inflation, but rather interest rates less the average expected inflation over the length of the loan. Subtracting the present inflation rate gives an inflation-adjusted interest rate. Often, since the future interest rates will be assumed to conform to an average of past rates and lenders use some such average as a proxy for expected inflation.)


Related Discussions:- Interest rates

What is cost of capital, What is Cost of Capital Cost of Capital is the...

What is Cost of Capital Cost of Capital is the rate which should be earned in order to satisfy required rate of return of the firm's investors. It may also be defined as the ra

Valuation of bonds and shares, three years ago, SSSG Ltd. issued 10 years $...

three years ago, SSSG Ltd. issued 10 years $1000 bonds with a 7% coupon rate paid semi-annually, at par value. the market currently requires a 9% yield. what was the price of bond

Contents of the offering memorandum, Contents of the Offering Memorandum ...

Contents of the Offering Memorandum Executive Summary: It constitutes one of the most important parts of the document and is the key selling chapter of the document. It should

Determine the optimal production quantity, Water Wheelies manufactures high...

Water Wheelies manufactures high-pressure sprinkler heads. These are produced periodically at a rate of 20,000 per month. Demand is steady at 15,000 per month. Each production run

Capiital budgating, calculate payback period of each project and according ...

calculate payback period of each project and according to payback whice project should be accepted

Show regression analysis to estimate the default probability, 1. The standa...

1. The standard approach here is to calculate some conventional ratios. These ratios can afterwards be used along with regression analysis to estimate the default probability.

How are financial trades made in an over-the-counter market, How are financ...

How are financial trades made in an over-the-counter market? Discuss the role of a dealer in the OTC market. In difference to the organized exchanges, which have physical locat

Finance case study, This case has been framed in order to test the skills i...

This case has been framed in order to test the skills in evaluating a credit request and reaching a correct decision. Perluence International is large manufacturer

Interest rate parity, QUESTION 1 (a) What are the differences between f...

QUESTION 1 (a) What are the differences between futures and forwards? (b) Clearly explain the following position on options i) Going long on a call option ii) Going lo

Explain speculator - market participants, Explain Speculator - Market Parti...

Explain Speculator - Market Participants A speculator attempts to profit from a modification in the futures price. For doing this, the speculator will take a long or short posi

Write Your Message!

Captcha
Free Assignment Quote

Assured A++ Grade

Get guaranteed satisfaction & time on delivery in every assignment order you paid with us! We ensure premium quality solution document along with free turntin report!

All rights reserved! Copyrights ©2019-2020 ExpertsMind IT Educational Pvt Ltd