Edited by Benton E. Gup
Chapter 7: Interest rates
Interest rates are important to individuals, businesses, and government entities. If you wish to borrow you need to find a lender and the two parties must agree to one interest rate if the loan is to be consummated. Because borrowers prefer a lower rate and lenders a higher rate it is important to understand the elements the two sides consider before mutually agreeing to execute the loan. Interest rates are also transmitters of incentives for or against economic activity. As such, interest rates are frequently the focus of government activities that focus on improving economic conditions. This is especially so when governments pursue monetary policy as central banks use the tools available to them to move interest rates in the direction that is believed to be desirable for the economy. INTEREST RATE DEFINITION Interest is the amount of money received by a lender from a borrower on a loan over and above the repayment of principal. The amount earned by the lender and paid by the borrower, when expressed as a percentage, is the rate of interest which is usually quoted on an annualized basis. It is important when talking about interest rates to consider both the lender’s and the borrower’s perspective. What rate of interest is the would-be lender willing to accept such that the would-be borrower agrees to pay that same amount? Only when such agreement is reached do we have a consummated loan.
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