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Concept
Interest rate
Summary
An interest rate is the amount of interest due per period, as a proportion of the amount lent, deposited, or borrowed (called the principal sum). The total interest on an amount lent or borrowed depends on the principal sum, the interest rate, the compounding frequency, and the length of time over which it is lent, deposited, or borrowed.
The annual interest rate is the rate over a period of one year. Other interest rates apply over different periods, such as a month or a day, but they are usually annualized.
The interest rate has been characterized as "an index of the preference . . . for a dollar of present [income] over a dollar of future income." The borrower wants, or needs, to have money sooner rather than later, and is willing to pay a fee—the interest rate—for that privilege.
Interest rates vary according to:
the government's directives to the central bank to accomplish the government's goals
the currency of the principal sum lent or borrowed
the term to maturity of the investment
the perceived default probability of the borrower
supply and demand in the market
the amount of collateral
special features like call provisions
reserve requirements
compensating balance
as well as other factors.
A company borrows capital from a bank to buy assets for its business. In return, the bank charges the company interest. (The lender might also require rights over the new assets as collateral.)
A bank will use the capital deposited by individuals to make loans to their clients. In return, the bank should pay interest to individuals who have deposited their capital. The amount of interest payment depends on the interest rate and the amount of capital they deposited.
Base rate usually refers to the annualized effective interest rate offered on overnight deposits by the central bank or other monetary authority.
The annual percentage rate (APR) may refer either to a nominal APR or an effective APR (EAPR). The difference between the two is that the EAPR accounts for fees and compounding, while the nominal APR does not.
Official source
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