 # What is interest rate in economics perspective

Table of Contents

## What is interest rate?

The interest rate is the interest percentage of the principal which is due per period and is imposed because of the use of money deposited, lent or borrowed.

As described in Wikipedia that interest rates are influenced by several considerations such as the policies of the central bank in order to accomplish the target of the government, the currency used when making the loan or borrowed, maturity of the investment, supply and demand from the market and also several other factors that might influence it.

## Interest rate calculation formula

How to calculate interest rates, for example, we will borrow \$ 1000 with an interest rate of 15% / year then we as borrowers must pay an excess of 15% at the end of the year or in other words \$ 1000 + 15% (\$ 150) then the total money must paid by the borrower is \$ 1150 and if the interest calculation from the rate if calculated in monthly installments for 1 year, the installments per month are \$ 1150/12 = \$ 95.83 ## What is interest rate in economics

Interest rates are an important part of economic calculation because along with high interest rates, the demand for borrowing money will be low because the price will be very expensive and when the demand for borrowing money decreases the interest rate can also weaken and when the interest rate drops it will there is a response with an increase in the number of loans because prices will be cheaper. When loans increase, it will affect investment, consumption and new business that will increase economic growth.

## What is interest rate swap

A derivative contract between 2 parties to exchange interest rates on the same currency

usually, the interest rate to be exchange is

a fixed rate against a floating rate

The reason why someone wants to do an Internet rate swap transaction is to protect the value of the potential for an increase/decrease in interest rates in the future.

### Interest rate swap example

If someone believes that interest rates tend to rise in the future and have a loan with a floating interest rate, then he can protect the value by doing Interest Rate Swap, by paying a fixed interest rate and receiving a floating interest rate.

Conversely, if he believes that interest rates tend to fall in the future and have a fixed rate loan, he can protect the value by doing Interest Rate Swap, by paying a floating interest rate and receiving a fixed interest rate.

## What is interest rate on savings account

The savings interest rate is the percentage of interest give by the bank to its customers within one period.

The existence of this savings interest as a profit sharing because they have already saved at the bank as you may already know that savings are one of the sources of bank funds in running a business.

### How bank calculate interest on savings account

#### Interest calculation based on the lowest balance

In this calculation method, the savings interest will be

calculated based on the lowest balance amount that occurs in the reporting month,

where the lowest balance will be use as a reference in calculating the interest.

Then the interest calculation = (lowest balance amount x interest rate% x number of days in the reporting month) / number of days in 1 year

#### Interest calculation based on an average balance

In interest calculation using this method is based on the average daily balance in the current month, so the value will be use as a reference in calculating interest.

Then the interest calculation = (Daily average balance x interest rate% x number of days in the current month) / Number of days in 1 year

#### Interest calculation based on daily balance

In interest calculation using this method will be based on the amount of the daily balance in the current month, so the basis for the calculation is to consider the balance of savings every day.

Then the calculation of interest = (Daily balance x interest rate% x number of days in the current month) / Number of days in 1 year.

## Real interest rate calculation

If a bank offers a 4% savings interest, do not immediately assume that our savings will bloom. Many of us feel that our savings are shrinking (purchasing power) even we gain 4% interest. Thus it is clear that saving in a bank with 4% is not investment or it is a bad investment.

To choose a decent investment, we must first understand what is a real interest rate, which is the real interest. The 4% interest mentioned is the nominal interest rate (nominal interest). However, due to high inflation (for example, 5% / greater than the nominal interest rate), the purchasing power of our money is even smaller (inflation – nominal interest rate = -1%). Real interest rate is the difference from nominal interest rate with inflation.

If you will choose an investment instrument, look at its real interest rate, not the nominal interest rate. For example, if I save in Japan there is no interest (0% nominal rate), but the inflation is -0.20% (deflation). Then the real interest rate is actually 0 – (-0.2) = + 0.2%. Japan is a rare example because this country has been deflation in a long time. Another example is India if the nominal interest is 7%, it looks high, even though the inflation is 9%, then we will lose money investing in Indian currency  (7-9 = -2%).

## What is interest rate on student loans

The interest rates for 2018-1919 federal student loans are now at 5.05% for undergraduate loans, for non-subsidized postgraduate loans of 6.60% and for direct loans of 7.60%.

Note: At the percentage of the loan interest rate there is a term annual percentage rate (APR) where the APR is the interest rate calculated for one full year, not just a monthly fee as applied to credit cards, loans, etc.

That’s some explanation about interest rates, if you are really interested in finance, it might be a good idea to read our reviews to manage personal finance here

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