Wednesday, January 11, 2012

risk free rate definitionWhat is the meaning of "return" in this sentence? Its from my economics book.?

The owners ( of a business ) could have purchased a government bond, which has no significant risk of default. Suppose the "return" on this is 6 percent per year. This amount is the risk free rate of return on capital. It is clearly an opportunity cost since the firm could close down operations, lend out its money, and earn a 6 percent "return".

They seem to use the word "return" here as if it is money gained. The confusion I am having is that I take the definition of a bond to mean money that is borrowed and if it is borrowed I do not understand why the lender would continue to give additional money. (The lender(government) already lent the business some money so why would it still pay the business 6 percent?). Could risk free rate definitionI have interpreted the word "bond" wrong? Could purchasing a bond actually mean lending money to someone else instead of someone else lending it to you? For instance could purchasing a government bond mean lending the government some money and could "the return" be a synonym for interest?
Here return refers to the amount of money which the owners of the business firm earn by purchasing the government bond.
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Return is the amount that is earned from the investment. as in , "I invested $1000 and it returned $1600 for a 60%.gain."

For a bond, the return is the interest paid.
The government is the borrower when a bond is srisk free rate definitionold. A business (or individual, foreign government) buys the bond and gives (or loans) the government money in exchange for interest. Both the loan and interest must be paid to the business, by the government.

So in a $1000 bond, the business will loan the government $1000. The interest, 6% ($60) is the amount above the $1000 the government pays back. So the $1000 is the principle, the 6% is the rate of return, $60 is the actual return.

It works the same way if you go to the bank and buy a CD (Certificate of Deposit). You buy the CD for $1000, and you are the lender. The bank is the one borrowing. In a government bond, the government is the one borrowing, the business is the one loaning to it.

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