Interest rates

DEFINITION of Interest rates

Interest rates are the amount that a creditor charges to a borrower for the loan of an asset, usually expressed as a percentage of the amount borrowed.

WHAT IT IS IN ESSENCE

That percentage usually refers to the amount which has to pay each year. But it can express payments on a more or less regular basis, also.

Interest rates can be simple or compound. Simple interest is derived from the original loan, that is the principal. You can calculate the compound interest from the principal plus any interest that results from the length of the loan.

So if a $100 loan has 5% compound interest, then after one year the interest would be 5% of $105 (the original %100 plus $5 in accrued interest).

Most bank interest rates are derived from the base rate set by their central bank: the rate at which private banks can borrow from their central bank. Central banks use interest rates to control inflation and spending.

By raising interest rates, the cost of borrowing and benefit from saving are both increased. That means that spending is discouraged. After the period of recession, many central banks dropped their incomes to encourage more spending.

HOW TO USE

Changes in the base rate can move markets in a major way, and be the major event for traders. Traders can also speculate on changes in the interest rate, either via instruments like bonds or derivatives.

Interest rates make the forex world go around!

In other words, the forex market is ruled by global interest rates.

A currency’s interest rate is probably the biggest factor in determining the perceived value of a currency.

So knowing how a country’s central bank sets its monetary policy, such as interest rate decisions, is a crucial thing to wrap your head around.

One of the biggest influences on a central bank’s interest rate decision is price stability or “inflation”.

Inflation is a steady increase in the prices of goods and services.