Final answer:
Investors should consider the rate of inflation, history, and risk level of the investment, tax obligations, the nominal interest rate, the length of the investment, and the expected rate of return. It's a misconception that long-term investments always carry higher risk. The example 15% interest rate chosen by the financial investor reflects the combined opportunity cost and a risk premium.
Step-by-step explanation:
Factors an Investor Should Consider When Making an Investment
When making an investment, an investor should consider several factors to make an informed decision. It is essential to consider the rate of inflation because it can erode the real value of investment returns. An investor should also look at the history of the investment to gauge its past performance and inherent risk level. Understanding the tax implications at both state and federal levels is crucial as they will affect the net return.
The nominal interest rate is significant; however, it must be analyzed in conjunction with the inflation rate to deduce the real rate of return. While the length of the investment does influence risk, it is not true that long-term investments always mean higher risk. Each investment should be evaluated based on its own merits, including the maturity date and liquidity. Lastly, the level of risk is directly proportional to the potential for both high returns and high losses.
By setting a benchmark interest rate reflecting the opportunity cost and risk premium, like the given example of a 15% rate, the investor values future payments in the present. Additionally, the expected rate of return is a critical estimate that reflects potential future interest payments, capital gains, or profitability increases from an investment.