The Basics of Interest Rate

by Investing School on March 16, 2010

Interest rate is something that is heard a lot when people are using credit. It means the rate or price borrowers will pay for the use of money that is not their own. For example, if a company is using a business loan from a bank to start its business then the return the lender will receive on that loan is the interest that is charged to the borrower for the use of those funds. Interest rates are usually characterized by a percentage rate that is extended over a period of one year.

Interest rates targets are a very important tool of monetary policy. They are used to control things like investment, inflation and unemployment. Throughout history, interest rates have been set by governments or by central banks.

Why are there changes in interest rates? This can happen for a variety of reasons. One of these reasons is deferred consumption. When a lender loans money, the lender will delay spending money on consumption goods. Since most people prefer having things right away instead of waiting for goods this usually means that in a free market there will be a positive interest rate.

Another reason that has recently hit close to home in the United States is risks of investment. There is always a risk that the borrower will not be able to pay back a loan or will go bankrupt or default on the loan. In some cases, the lender will charge a risk premium to mitigate some of these lending risks.

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