Interest rates

Vocabulary…………………………………………………………………………………..15
INTRODUCTION
Interest rate is one form of yield on financial instruments – that is, it is a rate of return paid by a borrower of funds to a lender of them. We can also think of an interest rates as a price by borrower for a service, the right to make use of funds for a specified period.
Economists talk about the rate of interest. This assumes that there is some particular interest rate that can be taken as representative of all interest rates in an economy. The rate chosen as the representative rate will vary depending on the question being considered. Sometimes, for example, the discount rate on treasury bills will be taken as representative. At other times the rate of interest on new local authority debt, the base interest rate of the retail banks, or a short-term money market rate such as LIBOR might be used. No matter which rate is chosen, it is implied that the interest rate structure is stable and that all interest rates in the economy are likely to move in the same direction. The interest rate structure describes the relationships between the various rates of interest rates in an economy on loans of different lengths (terms) or different degrees of risk.
NOMINAL AND REAL RATES OF INTEREST
There are nominal and real interest rates. The rates of interest quoted by financial institutions are nominal rates, allowing calculation of the amounts of money to be received as interest by lenders or paid by borrowers. This is clearly of immediate interest to borrowers and lenders. However, it is of equal importance to them to know how these amounts relate to their existing or likely future income and to the prices of goods and services. That is, a borrower wishes to know the opportunity cost of borrowing – how many...

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