Interest rate could be defined as a term that a borrower must have to pay, on the usage of money, for a specific period, the interest rate could also be defined as a tool for the companies. However, when the companies at the present value, discount the future cash flow, or the companies calculate the one dollar of today for the future amount.
Factors That Effect The Components of Interest Rates:
There are the five factors that can affect or influence the interest rate, as according to Investopedia they are,
Real-Risk Interest-Free Rate:
Real-risk interest-free rate is affected in the overall market, by the demand and supply of the money, it is calculated as the United State Treasury bond or amount that have the same period and the same amount.
Expected inflation can be described as a macroeconomic factor, the expected future prices are also represented by it. It could be defined as a basket of consumer products, as it is calculated according to the increase in the percentage of the prices.
Default Risk Premium:
Default risk premium could be defined as the ability of a borrower to pay back the loan, the borrower is at risk because interest rate could be higher. However, an interest rate is also affected by the liquidity premium.
The interest rate is also affected by the liquidity premium, the liquidity of the financial instruments, could indicate about the conversion of cash through the financial instruments. Moreover, higher interest rate is demanded by the investors who put the money, in low liquidity instrument.
Maturity premium could be defined as the primary component, which is used to determine the interest rate; the future cash flow is associated with the length of the period of maturity. There is the higher interest rate on the long time maturity because it is risky, however, due to the unexpected inflation rate and economic conditions risks are there, there are the probabilities that if the borrower may not pay the loan.