Interest rates, Financial Management

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.)

Posted Date: 10/17/2012 2:43:50 AM | Location : United States







Related Discussions:- Interest rates, Assignment Help, Ask Question on Interest rates, Get Answer, Expert's Help, Interest rates Discussions

Write discussion on Interest rates
Your posts are moderated
Related Questions
I need a paper on the financial status of the company under armour with ratios using information from yahoo.com finances. & Id like to provide a document with further details

Role of Primary Dealers To promote the investment activity in the Government Securities market, several countries have adopted licensed Primary Dealers (PDs) as important inter

there are 3 compaies i have to find out the price of equity share by using walters and gordons model.

john has two options from which to choose one: (a)Either to pay shs24m for the motor vehicle now . OR (b)To pay for the car in four equal regular installments of shs7m ea

List a few types of non-price rationing systems. (a) Queuing. (b) Favored customers. (c) Rationing coupons.

Issuing Procedure of treasury bills As discussed above, the RBI on behalf of central government, announces the auctioning of T-bills by tender notification through the press. T

PAMs are so structured that the repayments resemble traditional mortgages from the lenders' point of view and resemble GPMs from the borrowers' point of view. Thi


Putable bonds can be redeemed prior to maturity at the initiative of the bondholder. These bonds are more advantageous to the investors as they get an opportunity to re

Benefits of Going private company A public company has its shares purchased by a small group of people and ceases to be listed on stock exchange. This has many benefits includ