This will in turn increase the required rate of return.
ii) Time Preference for Consumption: If people choose to consume their income now rather to save, this will reduce the supply of investment capital oblivious to the demand of investment capital at that time. In this conditions, the firm's will find lesser sources lending investment capital and they try to attract more investment capital by offering them higher interest rate and this will again increase the required rate of return from the investment following the higher rate of interest that these firms will be offering. Similarly, if people decide to save now and spend later, this will lead excess supply of investment capital in the market. The firms here will be able to obtain investment capital at lower rates and will enjoy decreased interest expenses. Some projects that were not feasible because of high interest rates in the market will now become feasible and firms will borrow more. However, due to excess investment capital available in the market, the interest rate will decrease and so as the required rate of return.
iii) Risk: Risk requires compensation and likewise it will affect the interest rate of capital of investment. If the risk of an investment is high, then the investors will only be willing to invest in that project at very high interest rates. ...
iii) Risk: Risk requires compensation and likewise it will affect the interest rate of capital of investment. If the risk of an investment is high, then the investors will only be willing to invest in that project at very high interest rates. If the risk of a certain project is low, then the investors will be investing in that project at lower rates of return and interest rate. Hence, we can develop a relationship between interest rates and the risk of a project. These two variables are directly related with risk being the independent variable and interest being the variable depended upon risk factor of a project. Any increase in the risk factor is going to increase the interest rate or required rate of return of a project. Similarly, if the risk factor of an investment is low, so will be the interest rate. This clearly shows that risk requires compensation and interest rates vary depending on the risk factor of a project. A logical explanation to this is the fact that very few people are interested in investing in highly risky project fearing that they may lose out their money. As a result, the supply on investment capital is very low for these projects and vice versa.
Inflation: Inflation reduces the purchasing power of money. It erodes the purchasing power of people if their money is not invested into projects yielding interest rates which are at least equal to the going rate of inflation. If the interest rate earned is less that inflation, then you are losing out the real value of your money. This means that it won't be able to buy in the future, as much as it buying now. This is a dangerous situation for investors as they are faced with a situation in which the real value of their assets is decreasing. In times of inflations,