Interest Rates

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The interest rate is the price of money. It is the price to pay for using an amount of money during a certain time. Its value indicates the percentage of interest that must be paid in consideration for using a certain amount of money in a financial transaction.

 

Interest can be fixed, variable or mixed.

Fixed interest:

This interest rate remains constant for the duration or life of the loan. It is independent of the current interest rate of the market, ie if it were to rise, we would not be harmed, but if it fell, we would not benefit either.

It is calculated with the average of the interest rates of the previous months. Usually, your repayment term is between 12 and 15 years.

Variable interest:

Its amount is updated and revised in the terms established by the financial institution. It is subject to changes in interest rates. With variable interest we benefit from the decline in the interest rate, but we are also affected if it rises. Generally, a range is established within which the interest rate oscillates. Their repayment term may be longer than fixed interest.

Mixed interest:

In this type of interest, during the first years of life of the loan the interest rate is fixed and the rest of the time, until its completion, is variable.

Just as goods and services have a price that we must pay to be able to acquire them, money acts in the same way. Its use has a certain price, which is measured in percentage on a principal and is usually expressed in annual and percentage terms. Therefore, the interest rate is known as the price of money.

The discount rate is the inverse of the interest rate, which serves to increase the value (or add interest) on the present money. The discount rate, on the other hand, subtracts future money value when it is transferred to the present, except if the discount rate is negative, in which case it will assume that future money is worth more than the current one. The interest rate is used to obtain the increase to an original amount, while the discount rate is subtracted from an expected amount to obtain an amount in the present.

Its relationship with interest rates is as follows:

d = i / 1 + i

Being “d” the discount rate and “i” the interest rates.

Like goods and services, the interest rate depends on the law of supply and demand. That is, it is established by the market. Thus, the lower this interest rate, the greater the demand for financial resources will be and, on the contrary, the greater the demand for these financial resources. However, in the case of supply, the relationship with the interest rate is direct because the greater the willingness to lend money, the lower the interest rate, the less money lending will be required.

Obtaining a point of equilibrium with the association of these two variables establishes the value of the interest rate. Although the market is not the only one that indicates its value, there are also other important variables directly related to interest rates. These variables are:

The real interest rate of the public debt.

Expected inflation.

The liquidity premium.

Interest risk of each maturity period.

The credit risk premium of the issuer.

In addition, the central bank of the country sets an interest rate that affects all of the above factors. Its control allows it to implement expansive or restrictive economic policies by reducing or expanding it.

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