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Three Components of Interest Rate
Author: Bogie Boric
Friday, August 13, 2010 13:53     Reply
San Diego
California

Three Components of Interest Rate

Real Interest Rate (2%4%). This would be the amount a lender would charge if there were no possibilities of default and no expectation of inflation.

 

Expected Inflation (0%?). Lenders recognize that in an inflationary economy, they are being paid back with less valuable dollars. As a result, they increase their interest rate to compensate for this loss in purchasing power. When inflationary expectations are high, interest rates are high.

 

Credit Risk Premium (0%5%). The government has little or no credit risk (i.e., risk of nonpayment) when it issues bonds. A business enterprise, however, depending upon its financial stability, profitability, etc., can have a low or a high credit risk.

 

Real Interest Rate + Expected Inflation + Credit Risk Premium = Interest Rate.

Author: Anjani
Tuesday, July 08, 2014 02:51     Reply
Delhi
It always confuse me, but now I can understand how they calculate interest rate. Thanks for explaining three components of interest rate.
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