FIN 512 Lecture 4: 510 crib 1.docx
Document Summary
Nominal interest rate (rd): observed or stated interest rate. Real interest rate (rr): interest one would face in the absence of inflation, risk, illiquidity, and any other factors determining the appropriate interest. Risk-free interest rate (rf): interest rate on debt that is virtually free of default risk. Inflation: rising prices not offset by increasing quality of the goods or services being purchased. Inflation premium (ip): average expected inflation rate over the life of a risk-free loan, default risk premium (drp): additional interest rate premium required to compensate the lender for the probability that a borrower will default on a loan. Liquidity premium (lp):charged when a debt instrument cannot be converted to cash quickly at its existing value x e. Maturity premium (mp):premium to reflect increased uncertainty associated with long-term debt. Multiplier rf = rr + ip (for debt effectively default free borrowers) Rd= rr+ip+drp+lp+mp (for more complicated risky debt securities, determining mkt int rates) beg beg.
