Interest Rates –
Know Your Interest Rates
To Make The Correct Decision!
The knowledge of interest rates is very important for a person to decide on the options available whether he is about to invest or about to borrow. The price that a person has to pay for the funds he has been lent by someone. Interest rates are calculated for the loan amount and the term of the loan. Federal Reserve uses interest rates as the tools of the monetary policy.
The reasons for the interest rates are many. One of the reasons is the deferred consumption. By lending the money, the lender is not able to spend that particular amount for his use and so the interest is charged. Due to inflationary expectations, the amount lent will have lesser value in future and so the borrower needs to make compensation for this. The lender wants to be compensated for the anticipated decrease in the purchasing power of the money lent.
The risk involved in the investments is also the reason for charging interests. The possibility of the borrower going bankrupt or defaulting on the loan is always there. This is a big risk and so the lender charges interest to ensure that he is compensated even if someone defaults in payment. Liquidity preference is one of the reasons for charging interests. It means the preference to realize the value of the resources instantly.
The investments market is the major part of the economic system. Stock market, currency market, money market, bond market and financial institutions like banks come under the investment market. It is the rate of interest that balances the economic system. The rate of interest varies according to the type of investment or loan. The inflation has a great influence on the interest rates. The interest rates charged for secured loans like mortgages are lower than the interest rates charged for credit card loans and other unsecured loans. Generally the change in the interest rates is due to the change in the discount rate that is decided by the Federal Reserve.
There are many investment options like corporate bonds, treasury bills and so on that can yield good returns. The interest rates are either fixed or floating rate. The fixed rate securities offer fixed rate of interest for the specified maturity period and the floating rate investment options offer variable interest rate which is reset depending on the period of payment. Generally the debt securities interest rates are calculated either based on yield or bond market calculations or discount method decided by the Federal Reserve. Treasury bills and commercial papers are some of the investments that follow discount method while bank deposits fix rates depending on the yield.
When the demand for credit increases the interest rate also increases and with the demand for loans decreasing, we can see decrease in the interest rates as well.