Question

What is pure interest; that is, how does it come into being (how can one calculate pure interest) ; why is it always positive; and what is a good estimate of its level today (where does this estimate come from)?

Answer 1

Answer: The pure rate of interest is the charge for the use of money capital loaned out. It is that charged on loan which is totally riskless and have no administrative cost.

Calculation of pure interest: To find the pure interest rate, we take the nominal interest rate and subtract the inflation rate..

For example : If a loan has a 12% interest rate and inflation rate is 8% then the real return on that laon is 4%. In Calculating the real interest rates, we used the actual inflation rate .

Good estimate level of pure interest: anything under 5% is going to be good loan rate. And anything under 4% would be excellent.

Estimation is important in business and economics because too many variables exist to figure out how large scale activities will develop .Under pure interest valuations expectations theory plays relevant role. Helps the investor to make decisions based upon a forecast of future interest rates. Yes, there is need of estimates on pure interest as because of inflation rates are not constant. Prospective real Interest rates must rely on estimate of expected future inflation over the time to maturity of a loan or investment..