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

Explain about cash flow statement, Q. Explain about Cash Flow Statement? ...

Q. Explain about Cash Flow Statement? Cash Flow Statement: - This is another process of cash management. A cash flow statement is the statement showing inflows as well as outfl

Determination of values price and volume, Determination of values The v...

Determination of values The values for which NPV turns into zero are found by calculating the break-even values for the selected variables. Once determined these give an indica

Investment strategy of hedge funds, Investment Strategy OF HEDGE FUNDS ...

Investment Strategy OF HEDGE FUNDS After the Funds are raised from genuine investors, the next step for Hedge Funds is to invest them as per the investment objectives and strat

Explain total assets equal the sum of total liabilities, Why do total asset...

Why do total assets equal the sum of total liabilities and equity?  Explain. Assets = Liabilities + Equity Assets are the items of value that a business owns. Liabilities ar

Show internal business risk, Internal business risk associated with the ope...

Internal business risk associated with the operational efficiency of the firm. The operational efficiency differs from company to company. The efficiency of operation is reflected

Define the common pattern of cash flows, What is the common pattern of cash...

What is the common pattern of cash flows for a share of preferred stock? How does the market define the value of a share of preferred stock, specified these promised cash flows?

Rationale of accounting standards, Rationale of Accounting Standards A...

Rationale of Accounting Standards Accounting Standards are created along with a view to harmonise various accounting policies and practices in use inside a country. The goal o

Weighted average cost of capital, Chu Chu Train Systems is expected to pay ...

Chu Chu Train Systems is expected to pay a $3.25 annual dividend (D1 = $3.25), the dividend is expected to grow at a constant rate of 5.50% a year, and the common stock currently s

OPERATING CYCLE, discuss the applicability of operation cycle in avegetab...

discuss the applicability of operation cycle in avegetable growing business

What are the predator shareholders, What are the Predator shareholders ...

What are the Predator shareholders Predator company's shareholders mayn't approve the bid for various reasons. Reduction in EPS If consideration is

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