Interest Rate or Time Preference Rate

Ø Time Value for Money Individual investors generally prefer possession of a
given amount of cash now, rather than the same amount at some future time.
This time preference for money may arise because of (a) uncertainty of cash flows,
(b) subjective preference for consumption, and (c) availability of investment
opportunities. The last reason is the most sensible justification for the time value
of money.
Ø Risk Premium Interest rate demanded, over and above the risk-free rate as
compensation for time, to account for the uncertainty of cash flows.
Ø Interest Rate or Time Preference Rate Rate which gives money its value,
and facilitates the comparison of cash flows occurring at different time periods.
Ø Required Interest Rate A risk-premium rate is added to the risk- free time
preference rate to derive required interest rate from risky investments.
Ø Compounding Compounding means calculating future values of cash flows at
a given interest rate at the end of a given period of time.
Ø Future Value (F) of a Lump Sum Today (P) for n periods at i rate of interest
is given by the following formula: