Components of interest rate are those factors which determine the rate of interest for various investments, and They include the following;
- Real interest rate
Real interest rate is one of the components of interest rate; it is a compensation above and over-inflation that an investor wants from his money
- Inflation
This is simply a change in the price of commodities ion an economy. Inflation reduces one’s purchasing power. Therefore, an investor will be interested in inflation for compensation in the price reduction.
- Liquidity premium ‘
It is compensation that a lender is going to get for investing in a business that is difficult to sell. It compensates an investor for his or her illiquidity of the kind of investment engaged in.
- Default risk premium
This caters for the event that an investor or borrower fails to make
honor the repayment of the full amount agreed when due, riskier securities have higher default risk premiums.