The term frictional cost refers to the total amount to be paid for a transaction to be completed. This figure includes all of the costs, whether covertly stated or not. Examples of such costs are taxes, any amount accumulated over time, interest rates, research and development expenses, and other similar items. As such, the frictional cost for the completion of a transaction is not limited to just the principal amount and the interest rate.
The frictional cost is also sometimes referred to as transaction cost. However, another interpretation for transaction cost does not refer to the summation of all costs, which would include the principal amount and all incidental charges. On the contrary, this definition of transaction costs simply refers to the amount charged as commission and any other charges which may be incurred as the transaction is processed. The method of setting such a cost may vary. Some businesses or firms may set a flat rate, whereas others may set a rate which is to be used for the computation of this cost. Thus, the higher the principal amount, the higher the transaction cost would normally be.
For anyone entering into a transaction, especially those who are bound to do so on a regular basis, it is important to be aware of how transaction costs are set. This will enable one to be prepared to spend a certain amount, known as a spread, for the completion of transactions. For example, the purchase of a certain type of currency carries with it a certain charge which is to be paid to the foreign exchange agency selling the desired currency. In order to know how much of the base currency can be received for a certain amount of counter currency, one must be aware of both the exchange rate and the additional cost to be incurred in such a transaction.
