Summary
In this chapter we introduce some of the basic ideas that appear in the book. First, an overview of the chapter.
Interest rates
Interest rates are the life-blood of financial mathematics. To set up a new business, or to develop or diversify an existing business, you need to borrow money. To invest in a new idea, you need cash. To buy a home or an expensive item, such as a car, most people need to take out a loan. And when money is loaned, the person lending the money charges interest on the loan.
This is:
(a) to compensate the lender for the inconvenience of being parted from his/her cash.
(b) because there is always a chance that not all the money will be re-paid, the lender is rewarded for exposing themselves to risk; the interest payments are that reward.
Variations in interest rates
In general, there will be a different interest rate for loans extending over short periods than for loans over longer periods. Over a longer period, the owner of the money has to manage without that money for a longer time and the risk of default on the loan becomes greater. So generally, loans over longer periods carry a higher interest rate. However, some loans carry far greater risk than others. A loan of £10,000 to a school mathematics teacher, married with children, might carry less risk than a loan of the same amount to a one-legged trapeze artiste.
- Type
- Chapter
- Information
- Financial ProductsAn Introduction Using Mathematics and Excel, pp. 34 - 68Publisher: Cambridge University PressPrint publication year: 2008