" **Create an educational video to explain the CFA Level 1 knowledge:** **Interest Rates and Time Value of Money——Determinants of Interest Rates** **Content Requirements:** * Start with a clear, beginner-friendly definition of the concept * Explain the core components and logic step by step * Include simple numerical examples or visual analogies * Add a short summary or key takeaways at the end * Ensure the structure follows a logical teaching flow from concept to application * **Use slow and steady pacing when narrating, making the explanation easy to follow and digest** **Visual and Layout Requirements:** * Full-screen visuals with centered, readable content * Use smooth animations to transition between steps or sections * Highlight important terms, formulas, and keywords with bright accent colors (e.g., yellow, red, blue) * Avoid text crowding or overlap; leave clear visual spacing * Use animated icons, graphs, or diagrams where appropriate (e.g., timelines, flowcharts, charts) * Minimize blank space; keep each screen visually rich and balanced **Tone and Style:** * Friendly, clear, and professional * Focus on making the topic accessible for first-time learners * Avoid excessive jargon; use plain language wherever possible * Maintain alignment with CFA curriculum terminology and scope * **Speak slowly and clearly, ensuring every key point is explained in simple, understandable terms** "

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Welcome to our CFA Level 1 lesson on interest rates and time value of money. Today we will explore the determinants of interest rates. An interest rate is simply the price of borrowing money, or alternatively, the return you receive for lending money. Understanding what determines these rates is crucial for financial analysis. The foundation of all interest rates is the Real Risk-Free Rate, denoted as R-star. This is the theoretical rate on a single-period, risk-free security in a world without inflation. The real risk-free rate reflects two fundamental economic concepts. First, time preference - people naturally prefer to have money now rather than later. Second, opportunity cost - when you lend money, you give up other potential uses for that money. These concepts form the baseline return that lenders require. Now we add the Inflation Premium, or I-P. Inflation erodes the purchasing power of money over time. When you lend money today, the dollars you receive back in the future will buy less than they do today. Lenders require compensation for this expected loss of purchasing power. The Inflation Premium equals the expected rate of inflation over the life of the investment. For example, one hundred dollars today will buy less goods and services in the future due to inflation. Next is the Default Risk Premium, or D-R-P. This compensates lenders for the risk that the borrower may not repay the principal or interest as agreed. The higher the perceived risk of default, the higher the default risk premium required. For example, government bonds typically have low default risk premiums because governments rarely default. Corporate bonds have higher default risk premiums, and junk bonds have very high default risk premiums due to their elevated risk of non-payment. Now let's put it all together. The nominal interest rate that we observe in the market is the sum of all these components. The formula is: Nominal Interest Rate equals R-star plus I-P plus D-R-P plus L-P plus M-P. Here's a simple example: if the real risk-free rate is 2 percent, inflation premium is 3 percent, default risk premium is 1 percent, liquidity premium is 0.5 percent, and maturity premium is 0.5 percent, then the total nominal interest rate would be 7 percent. This framework helps us understand why different investments have different interest rates.