inflation factor

The threat of further inflation will continue to be of major importance to all investors. Because this whole matter has such great investment importance. When its true cause is understood, the investoris unlikely to be confused in his basic thinking by various dogmatic comments of some of our political leaders.

The first thing to consider,of course, is just what we mean by inflation. While there are many complex definitions,For practical purposes, it is sufficient to consider inflation as a condition where by (with only minor and temporary reversals) the total amount of things and services that can be obtained for the same number of money.

In a free economy, capital is allocated through the price system. An interest rate is the price paid by a borrower for the use of an investor's capital.

Interest rates provide the vehicle for allocating capital among firms. In a perfect free-market economy, firms with the most profitable investment opportunities attract capital away from companies with less inviting investment opportunities arising from problems such as inefficiency, low demand for products, poor management, etc. However, a perfect free-market economy doesn't exist. There are imperfections, usually introduced by governments, that lead to the allocation of capital to firms that do not necessarily have the most profitable investment opportunities.

Let's look at some of the factors that influence the level of interest rates

The stated or offered rate of interest (r) reflects three factors:
•Pure rate of interest (r*)
•Premium that reflects expected inflation (IP)
•Premium for risk (RP)

Each of these factors increases the stated interest rate. The resulting interest rate calculation is:

r = r* + IP + RP