For many centuries, religious institutions, among others, opposed the payment of interest because they considered usury....

For many centuries, religious institutions, among others, opposed the payment of interest because they considered usury. From a finance perspective, however, interest payments (on personal loans, bonds, and other instruments) are justified for three main reasons. Explain what these three reasons are.

Expert Solution

Justification for interest payments

From a finance perspective, interest payments (on personal loans, bonds, and other instruments) are justified for three main reasons. They are:

Tenure of the debt or Inflation rate : The value of the borrowed amount will decrease if the period of the loan is long term. Interest can be charged to compensate such loss for the lender.
Reduce the risk of default : The borrower may fail to repay the money on time. Such risk of default can be compensated by charging a certain percentage of interest on the debt instruments.
Interest compensate the inconvenience for unavailability of fund for lender's own use : When the people lend money, they cannot use the money for their own purpose. For covering such inconvenience also, the interest can be charged.

Moreover the interest performs an Economic function. It influences the level of investment in the economy. Allocation of savings is possible with the presence of interest payments for debt instruments.

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