Interest Rate

Interest rate is: the amount imposed by the lender on the borrower for the use of the borrowed principal, and it is typically expressed as a percentage of the borrowed amount. This percentage usually indicates the amount paid each year (referred to as the annual interest rate), but it can also be used to express payments on a more or less regular basis.

Interest rates can be simple or compound: Simple interest is calculated on the initial loan amount (the principal). Compound interest is calculated on the principal amount plus the interest accrued over the entire loan period. So, if a loan is $100 and carries a compound interest rate of 10%, the interest after one year would be 10% of $110 (the original $100 plus $10 in accrued interest).

Most commercial interest rates are derived from the base interest rate set by the central bank. The base interest rate is the rate at which commercial banks can borrow from the central bank.

Central banks use interest rates to control inflation and spending. Raising interest rates increases the cost of borrowing and savings interest, thereby reducing spending. During a recession, many central banks lower interest rates to encourage more spending. Investors can also speculate on interest rate changes using instruments like bonds or derivatives.

Traders pay attention to interest rates because they impact the movement of currency and commodity prices.

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