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Financial Management: Interest Rates

This document discusses various topics related to interest rates, including: - Organizations are categorized as debtors or creditors based on whether they borrow or lend funds. Interest rates create equilibrium between borrowers and lenders. - Interest rates represent the cost of borrowing funds, while required return focuses on returns from owning common stock. Both represent compensation for suppliers of funds. - Inflation and deflation affect investor preferences, as investors prefer short-term obligations when prices are fluctuating. The liquidity of a firm also impacts investor decisions. - The real rate of interest assumes a perfect market without inflation or risk premiums. The nominal rate includes inflation and risk premiums, which is the difference between real and nominal

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Arif Sharif
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34 views

Financial Management: Interest Rates

This document discusses various topics related to interest rates, including: - Organizations are categorized as debtors or creditors based on whether they borrow or lend funds. Interest rates create equilibrium between borrowers and lenders. - Interest rates represent the cost of borrowing funds, while required return focuses on returns from owning common stock. Both represent compensation for suppliers of funds. - Inflation and deflation affect investor preferences, as investors prefer short-term obligations when prices are fluctuating. The liquidity of a firm also impacts investor decisions. - The real rate of interest assumes a perfect market without inflation or risk premiums. The nominal rate includes inflation and risk premiums, which is the difference between real and nominal

Uploaded by

Arif Sharif
Copyright
© © All Rights Reserved
Available Formats
Download as PPTX, PDF, TXT or read online on Scribd
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FINANCIAL MANAGEMENT

INTEREST RATES
Class: FA19-BBA-E (5th)
Teacher: Muhammad Arif
TOPICS INCLUDED

 Organizations according to debtors and creditors


 Interest Rates Concepts
 Interest Rate and Required Return
 Inflation and deflation
 Stakeholder preferences based on firm’s liquid position
 Real Rate of Interest
 Nominal rate of Interest
 Interest and the related composition
DEBTORS AND CREDITORS

 Debtors are borrowers of the organization. Such borrowers are responsible to


repay the respective debt.
 Creditors are the lenders of the organization. The organization is responsible to
repay the respective debt to creditors as per specified obligations.
 The organization which has provided debt to borrowers, tries to obtain maximum
benefit through interest.
CONTINUED…..

 The organization which has received the debt, tries to pay minimum in terms of
interest.
 In such a situation, interest rate creates a state of equilibrium among the
borrowers and lenders.
INTEREST RATE AND REQUIRED RETURN

 Interest rate are cost of borrowings funds.


 Required return focuses on common stock.
 Interest rate is a general compensation, expected by the lender and terms to be
paid by the borrower.
 Required return is associated with the cost of funds obtained by the selling the
ownership of interest (via common stock).
CONTINUED…..

 In general, interest rate and required return showcase the similar concepts. The
fund supplier gets the specified compensation from the borrower.
INFLATION EFFECTS

 The increasing trend in general prices of the goods and services is associated with
Inflation.
 Such decreasing trend is associated with deflation.
 In general case, the investors predicts the prices to fluctuate with time.
 Investors prefer short-term obligations.
 Liquidity of the firm’s affect investors decisions.
REAL RATE OF INTEREST

 It assumes the perfect market.


 Creates the equilibrium between supply and demand for investment funds.
 No position of Inflation
 No liquidity preference is assumed
 No risk premium is assumed.
NOMINAL RATE OF INTEREST

 It is actual rate of interest charged by the funds supplier and obligation to be paid
by the demander.
 It assumes inflation.
 It considers the application of risk, which involves risk premium.
 The difference of real rate of interest and nominal rate of interest is associated
with two factors. i.e., Risk and Inflation.
INFLATION AND RISK PREMIUM

 When investors demand higher rate of interest due to expected inflation, then this
expected higher rate of return is inflation premium.
 It is denoted as IP

 When investors demand higher rate of interest due to expected risk, then this
expected higher nominal rate of return is risk premium.
 It is denoted as RP
CONTINUED…..

 r1= r* +IP + RP1


 R1 represents Nominal rate of Interest
 R* represents Real rate of Interest
 IP represents Inflation premium
 RP represents Risk Premium
 Rf = r*+IP
 Rf represents Risk free rate
 r1= Rf + RP1
NEXT LECTURE…..

 Structure of Interest rate and numerical problems.

Thankyou

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