Revista de Economía y Negocios

The Interest Rate Algebra

Abstract

Yuriy V Kozyr

This article considers the structure of interest rate, applied for discounting of risky cash flows. The purpose of the article is a presentation of ways of reflecting inflation and risks in the calculation of risk discount rate. In introduction on base of well-known dependences is shown that risk premium depends on inflation rate and (for multiplicative-type models) risk free rate. In the first part of the article three Interest rate algebras are presented. They describe the attitude between nominal discount rate, risk free rate, inflation rate and risk-premium. This algebras can presents in additive-type or multiplicative-type versions and have given risk premium value without detailed description the structure of risk premium. The second part of the paper has more detailed attitude between risk premium, risk free rate and mathematical expectation of losses because of bankruptcy/default. It is shown that the obtained dependences are slightly different and depends on the initial preconditions calculation: the principle of arbitration or the principle of certainly equivalent.