See Also:
Effective Rate of Interest Calculation
Interest Expense
What are the 7 Cs of banking
Time Value of Money (TVM)
Interest Rate RiskInterest Rate
An interest rate signifies a borrowing cost. It is the rate the lender charges the borrower for the use of money. Interest rates are usually quoted as annual rates which represent a percentage of the borrowed principal. Interest rates are used in all types of business and consumer
loans, including auto loans, mortgages, credit cards, and any other contract that involves a borrower and a lender. A borrower with good credit – and therefore less risk of default – can borrow money at a lower rate than a borrower with poor credit.
Benchmark Interest RatesBusiness and consumer loans, as well as interest rate derivatives (see below), often rely on benchmark interest rates, such as the fed funds rate, the
prime rate,
Libor, or U.S. Treasury rates. For example, a company may borrow money from a commercial bank at a rate equal to the prime rate plus a specified quoted margin. The quoted margin, or spread between the benchmark rate and the interest rate used in the loan, would depend on the credit standing of the borrower.
Interest Rate DerivativesInterest rates are also frequently used in financial derivatives, such as interest rate futures and
interest rate swaps. With financial derivatives, the value of the derivative instrument depends on fluctuations in the underlying interest rate.
Calculate Interest on LoanSimple Interest = Principal x Interest Rate x Time PeriodsCompound Interest = Principal x (((1 + Interest Rate)^Time Periods) – 1)Interest Payment = Principal x Interest RatePrincipal = Interest Payment / Interest Rate