FinMan

Interest Rates
Factors Affecting Level of Interest

Production Opportunities

Time Preferences for Consumption

-before production opportunities

Time preference for consumption and big income

-mahirapan pa rin maglend and magsave

The harder to lend = the higher the interest rate

The easeier to lend = the lower the interest rate

Risk

-opportunity costs to outside lenders

Lots of investment opportunity – but risky – then lending it outside – low rates
Lots of investment opportunity – but risky – then lending it to higher opp costs – higher
rates

Inflation
-increase of prices overtime

Nominal vs Real Rates

r = nominal rate

r* = real risk free rate of interest

rRF= rate of interest on treasury securities

r = r* + IP + DRP + LP + MRP

DRP – default risk premium, risk that bonds are equal to maturity, mababayaran ba
instalments
The longer the riskier it gets

IP – inflation premium

LP – liquidity premium, risk that liab cannot be easily converted to cash overtime
Kapag me collateral – di rin madali iconvert sa cash
The quicker conversion, the better, less risks
MRP – maturity risk premium,
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Interest Rates
Companies raise capital through debt and equity.

Capital is allocated in the market and establishes prices.

Interest Rates are the price that lenders receive and borrowers pay for debt capital with
which they receive dividends and capital gains (c0st of equity).

In this chap, cost of debt.

Interest rates on different types of debt vary depending on the borrower's risk, the use of
the funds borrowed, the type of collateral used to back the loan, and the length of time
the money is needed + relationship sa cost of debt/money

Cost of Money Factors

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Interest Rates
Nominal vs Real Rates

r = nominal rate, quoted rate, given rate on a security

r* = real risk free rate of interest, rate of interest that would exist on a riskless security if
no inflation is expected

rRF= r* + IP
the quoted rate of risk-free security which is free and most liquid

r = r* + IP + DRP + LP + MRP

or

r = rRF + Ip + DRP + MRP

DRP – default risk premium, risk that bonds are equal to maturity, mababayaran ba
instalments, the longer the riskier it gets
- The possibility that issuer will not pay

IP – inflation premium
IP = average expected rate of inflation / life of security

LP – liquidity premium or marketability, risk that liab cannot be easily converted to cash
overtime
Kapag me collateral – di rin madali iconvert sa cash
The quicker conversion, the better, less risks

MRP – maturity risk premium, the longer-term bonds are exposed to significant risks of
price declines, charged by lenders to reflect said risk
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Interest Rates
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Interest Rates