Interest rate producer loans vs Capital Strucutre

  • This topic has 2 replies, 2 voices, and was last updated 11 years ago by rt.
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  • #17654
    rt
    Member

    Hi Dr. Herbener,
    I’m currently watching the lecture on the Time Market and have some difficulties to get my thoughts across some things and it’s difficult to exactly explain it, but let me try:
    The way I understand it is: The rate of interest in the Capital structure is determined by the time preferences of the entrepreneur and is a premium for the money he’s giving up in the present or a discount of the expected revenue in the future. I think I understand that even if my expression is poor and not 100% accurate (I’m not english speaking).
    Now to the primal question(s):
    What is the link between this interest rate and the interest rate of producer loans? Is one determined by the other? Are they the same? Can they differ from one another and if yes, is this relevant for the entrepreneur? Thanks so much!

    #17655
    jmherbener
    Participant

    The pure rate of interest is determined by the time preferences of everyone in society. Lenders, who have lower time preferences, supply present money to borrowers, who have higher time preferences. The pure rate of interest is at the level that clears the market, i.e., at which the quantity demanded of present money is the same as the quantity supplied.

    Arbitrage by lenders keeps the pure rate of interest the same across the time market. If the 2 year corporate bond rate is 5%, then the rate of return on investment in 2 year production processes in the capital structure will also be 5%.

    If circumstances differ between two types of loans, then their market rates of interest will differ even if they have the same time preference premium. If the two year corporate bond is AAA at 5% and the two year investment project is riskier, then its interest rate will be above 5%.

    #17656
    rt
    Member

    Okay I think I understand!

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