CHAPTER 9
The Role of Risk on the Interest Rate
Introduction
In the previous two chapters we referred to risk and how interest rates must be adjusted to reflect the risk associated with different ventures, as well as the borrowers’ risks. Many important issues about risk were not discussed. What risk is, how it is calculated, and how it affects interest rates are some of the more obvious questions that were left unanswered.
The difference between risk and uncertainty is that the former has a possible undesirable consequence. The lower the probability, the less the chance of occurrence of the outcome, while the higher the probability, the greater the chance of occurrence. The smallest probability of occurrence is zero, while the largest is one. ...
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