Question

What are the components of an interest rate? Why is it important for accountants to understand these components?

Answer 1

Below are the generally components in interest rate :

• Pure rate of interest— Interest charged without taking into account inflation and credit risk.
• Expected inflation rate of interest—Lenders recognize that in an inflationary economy, they are being paid back with less valuable dollars. As a result, they increase their interest rate to compensate for this loss in purchasing power. When inflationary expectations are high, interest
• Credit Risk:This the risk of non-payments, needs to be taken,depending upon its financial stability, profitability, etc. can have a low or high credit risk

Accountants must have knowledge about these components because these components are essential in identifying an appropriate interest rate for a given company or investor at any given moment