INTEREST RATES

INTEREST RATES

PRELIMINARY ECONOMICS


INTEREST RATES

Interest rate is the cost involved when money is borrowed so that goods and services can be purchased now rather than in the future. Therefore interest is the cost involved for the use of that money. This cost is often referred to as the price which has to be paid for liquid capital.

An Interest rate is comprised of three parts that are necessary to compensate the lender for lending money. There parts are compensation for

• Risk- in lending money there is a risk involved that the lender may loose part or the entire original amount lent.
• Inflation- in times of price inflation the principal loses purchasing power and the longer the period of loan and the higher the rate of inflation the greater the value that would be lost
• Waiting- by waiting, the lender is forgoing present spending on goods or services or the ability to invest elsewhere.

Since inflation affects everyone in the economy to s...