Interest Rates Finance

By: EconomyWatch Content   Date: 4 November 2009

About The Author

EconomyWatch Content

Follow The Money

EconomyWatch, Content Team

 

  • Dot Div
  •      

The interest rate is the price charged by lenders from borrowers for the loaned amount on an annual basis. Similarly, when a person deposits his money in a bank or financial institution, the bank pays an interest for using the person’s money. Interest rates can fluctuate based on factors, such as demand and supply. In a free market economy, however, the only factors determining interest rates are supply and demand. In extreme situations, when people suffer due to the value of money and interest rates, central banks intervene to rectify the problem. They adjust the demand and supply of money through various instruments.

Interest Rates Finance – Types 

Interest rate is generally expressed as a percentage of the total amount lent. There are many types of interest rates, including nominal, real and market interest rates.

Nominal and Real Interest Rates: Nominal interest rate is the amount of interest payable. For example, a person deposits $1000 in a bank for one year and he receives an interest of $100. At the end of the first year, the balance is $1100. The nominal interest rate here is 10% per year. The real interest rate is calculated by adjusting the nominal interest rate charge to take inflation into account. Real interest rate measures the buying power of interest receipts. Suppose the inflation rate is 10% in the above example, the real interest rate is zero. This is because the amount at the end of the year ($1100) can buy only the same amount of goods that $1000 could buy at the start of the year.

Market Interest Rates: The money market, stock market, bond market and currency market are part of the market for investments. Retail financial institutions like banks also belong to this market. Economists believe that there are four factors that affect the yield of any investment, namely inflation expectations, the risk-free cost of capital, costs of the transaction and the level of risk in the investment.

Inflation plays a crucial role in both financial and market interest rates. However, countries cannot get rid of inflation, since mild inflation is necessary for all economies to grow.


  • Dot Div
  •      

Most Popular in Interest Rates

Related Links
blog comments powered by Disqus