BY
ROSHAN SOB
MBA
MUSOM
sob7roshan@gmail.com

 interest rate is the amount charged, expressed as a
percentage of principal, by a lender to a borrower for
the use of assets. Interest rates are typically noted on
an annual basis, known as the annual percentage
rate (APR). The assets borrowed could include,
cash, consumer goods, large assets, such as a vehicle
or building. Interest is essentially a rental, or leasing
charge to the borrower, for the asset's use. In the case
of a large asset, like a vehicle or building, the interest
rate is sometimes known as the "lease rate". When the
borrower is a low-risk party, they will usually be
charged a low interest rate; if the borrower is
considered high risk, the interest rate that they are
charged will be higher.

1) Real Risk-Free Rate - This assumes no risk or
uncertainty, simply reflecting differences in
timing: the preference to spend now/pay back
later versus lend now/collect later.
2) Expected Inflation - The market expects aggregate
prices to rise, and the currency's purchasing power
is reduced by a rate known as the inflation rate.
Inflation makes real dollars less valuable in the
future and is factored into determining the
nominal interest rate (from the economics
material: nominal rate = real rate + inflation rate).

3) Default-Risk Premium - What is the chance that
the borrower won't make payments on time, or
will be unable to pay what is owed? This
component will be high or low depending on
the creditworthiness of the person or entity
involved.

4) Liquidity Premium- Some investments are highly
liquid, meaning they are easily exchanged for
cash (U.S. Treasury debt, for example). Other
securities are less liquid, and there may be a
certain loss expected if it's an issue that trades
infrequently. Holding other factors equal, a less
liquid security must compensate the holder by
offering a higher interest rate.

5) Maturity Premium - All else being equal, a bond
obligation will be more sensitive to interest rate
fluctuations the longer to maturity it is.

According to this theory rate of interest is
determined by the intersection of demand and
supply of savings. It is called the real theory of
interest in the sense that it explains the
determination of interest by analyzing the real
factors like savings and investment.
 classical economists maintained that interest is
a price paid for the supply of savings.

 Demand for savings comes from those who want to
invest in business activities. Demand for investment
is derived demand. Any factor of production is
demanded for its productivity. The demand for the
factor is high when there are higher expectations
from it

 Supply of capital is the result of savings. It comes
from those who have the excess of income over
consumption.
 On a higher rate of interest people save more to earn
the befefits.
 At the low rate of interest people save less

 According to classical theory, equilibrium interest
rate is restored at a point where demand for and
supply of capital are equal.
 Rate of interest is in equilibrium only at a point
where the demand for capital equals the supply of
capital.

 The liquidity preference theory suggests that an
investor demands a higher interest rate, or premium,
on securities with long-term maturities, which carry
greater risk, because all other factors being equal,
investors prefer cash or other highly liquid holdings.
 Interest rates on short-term securities are lower
because investors are sacrificing less liquidity than
they do by investing in medium-term or long-term
securities.

 The rational expectations theory is an economic
idea that the people make choices based on their
rational outlook, available information and past
experiences.
 The theory suggests that the current expectations
in the economy are equivalent to what people
think the future state of the economy will
become.
 This contrasts with the idea that government
policy influences people's decisions.

 The benchmark interest rate in Nepal was last
recorded at 7%
 Interest in Nepal averaged 6.75% from 2003
until 2016, reaching an all tie high of 8% in July
of 2012 and record of 5.50% in September of
2003