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Interest Rates
An interest rate is the price a borrower pays for the use of money he does not own, and the return a lender receives for deferring his consumption, by lending to the borrower. Interest rates are normally expressed as a percentage over the period of one year.
Interest rates are also a vital tool of monetary policy and are used to control variables like investment, inflation, and unemployment.
Real vs nominal interest rates
The nominal interest rate is the amount, in money terms, of interest payable.
For example, suppose a household deposits $100 with a bank for 1 year and they receive interest of $10. At the end of the year their balance is $110. In this case, the nominal interest rate is 10% per annum.
The real interest rate, which measures the purchasing power of interest receipts, is calculated by adjusting the nominal rate charged to take inflation into account. (See real vs. nominal in economics.)
If inflation in the economy has been 10% in the year, then the $110 in the account at the end of the year buys the same amount as the $100 did a year ago. The real interest rate, in this case, is zero.
Interest rate notations
What is commonly referred to as the interest rate in the media is generally the rate offered on overnight deposits by the Central Bank or other authority, annualised.
The total interest on an investment depends on the timescale the interest is calculated on, because interest paid may be compounded.
In finance, the effective interest rate is often derived from the yield, a composite measure which takes into account all payments of interest and capital from the investment.
In retail finance, the annual percentage rate and effective annual rate concepts have been introduced to help consumers easily compare different products with different payment structures.
From Wikipedia, the free encyclopedia
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