When a company decides to use funds to install capital that will not begin to produce income for several years, it needs a way to compare the significance of funds spent now to income earned later It must find a way to compensate financial investors who give up the use of their funds for several years, until the project begins to pay off How can payments that are distributed across time be linked to one another? Interest rates are the linkage mechanism; we shall investigate how they achieve that linkage in this section The Nature of Interest Rates Consider a delightful problem of choice Your Aunt Carmen offers to give you $10,000 now or $10,000 in one year Which would you pick? Most people would choose to take the payment now One reason for that choice is that the average level of prices is likely to rise over the next year The purchasing power of $10,000 today is thus greater than the purchasing power of $10,000 a year hence There is also a question of whether you can count on receiving the payment If you take it now, you have it It is risky to wait a year; who knows what will happen? Let us eliminate both of these problems Suppose that you are confident that the average level of prices will not change during the year, and you are absolutely certain that if you choose to wait for the payment, you and it will both be available Will you take the payment now or wait? Chances are you would still want to take the payment now Perhaps there are some things you would like to purchase with it, and you would like them sooner rather than later Moreover, if you wait a year to get the Attributed to Libby Rittenberg and Timothy Tregarthen Saylor URL: http://www.saylor.org/books/ Saylor.org 679