The Time Value of Money and Interest Rates Flashcards
What does the time value of money concern?
Time value of money concerns equivalence relationships between cash flows occurring on different dates.
What is the real risk free interest rate?
The real risk-free interest rate is the single-period interest rate for a completely risk-free security if no inflation were expected.
What is the inflation premium?
The inflation premium compensates investors for expected inflation and reflects the average inflation rate expected over the maturity of the debt.
How do you calculate the nominal risk-free interest rate?
Add the real risk-free interest rate and the inflation premium.
What is the default risk premium?
The default risk premium compensates investors for the possibility that the borrower will fail to make a promised payment.
What does the liquidity premium compensates?
The liquidity premium compensates investors for the risk of loss relative to an investment’s fair value if the investment needs to be converted to cash quickly.
What is maturity premium?
An extra return that compensates investors for the increased sensitivity of the market value of debt to a change in market interest rates as maturity is extended.
