Hermitage

( Crosson , S .V Needles , B .E . 2008

Components of a discount /interest rates

A sum of five different components makes up the rate of return at which an investment trades in financial theory the five components are discussed here below and include

a ) The real risk-free interest rate

This forms the basis at which all other investments are analyzed and compared . It is basically the rate of return an investor would expect to earn in risk less environment devoid of any form of inflation (Carl S W et al 2001 p

b ) An Inflation Premium

To adjust an investment 's expectation for a future inflation a certain rate is added towards this purpose this is what is termed as the inflation premium (Carl S . W et al 2001

c ) Liquidity Premium

Liquidity premium is required in circumstances where investors are not willing to pay for the full value of the stocks or assets especially if there is a possibility of not selling them as quickly as they would wish because of buyer scarcity . The liquidity premium serves the purpose of compensating the potential loss . How big a liquidity premium is , is dependent on the investors perception of the activity of the market . A good example of where the liquidity premium is required is in such investments as family controlled company with thinly traded investments like bonds and stock (Carl S . W et al 2001

d ) Default risk premium

Default risk premium indicates how investors perceive the likelihood of a company defaulting to meet its obligation or the likelihood of it going bankrupt . In most cases when there are telltale signs of a company in trouble , the investors demand a default risk premium which eventually leads to the collapse of the company (Carl S . W et al 2001

e ) Maturity Premium

The...