Interest rate
What is Interest rate?
An interest rate is the price of borrowing money or the compensation for lending, expressed relative to principal and time.
When displaying historical rates, preserve the curve observed on each date rather than applying today's rate retrospectively. That prevents look-ahead bias and makes it possible to distinguish income actually available then from later changes in market value.
What a quoted rate means
Rates differ by currency, maturity, borrower, seniority, collateral, liquidity, tax treatment, and compounding convention. A nominal annual rate does not account for inflation, while a real rate does. Simple, effective, continuously compounded, annual percentage, and annual percentage yield conventions are not interchangeable. Any comparison should align cash-flow timing, fees, day count, and compounding.
How rates are formed
Short rates are strongly influenced by central-bank policy and expectations for its future path. Longer yields also reflect expected short rates, inflation, term premium, liquidity, and security-specific risks. Borrower rates add credit and other spreads to a reference curve. Supply and demand, regulation, collateral value, and market functioning can move rates even without a change in expected economic growth.
Prices and present value
An asset's value can be expressed as future cash flows discounted at rates appropriate to their timing and risk. When the required rate rises, the present value of fixed cash flows falls, all else equal. The sensitivity is greater for cash flows farther in the future. Duration and convexity approximate this relationship for bonds, but embedded options and changing credit spreads require additional analysis.
Portfolio relevance
Rates affect bond prices, equity valuation, mortgages, financing costs, currencies, bank margins, real estate, and the attractiveness of cash. The same rate rise can signal healthy growth or restrictive policy, producing different asset reactions. Investors should decompose curve, inflation, real-rate, and spread changes instead of treating every movement as a single undifferentiated interest-rate factor.
Practical checklist
Specify whether a rate is spot, forward, yield to maturity, coupon, policy, overnight, swap, government, or corporate. Match currency and horizon to the liability or valuation. Stress parallel and nonparallel curve changes, refinancing, floating-rate resets, and basis risk. Avoid using one government yield as universally risk-free, particularly across currencies, horizons, taxes, or investors with different collateral and funding constraints.
Sources and further reading
- Monetary Policy, Board of Governors of the Federal Reserve System
- Treasury Term Premia, Federal Reserve Bank of New York