Interest Price

Interest Price

Interest, the price paid for the use of loanable funds. It is normally expressed as so much per cent per year, although it could be expressed as per cent per month or five years. There are many rates of interest; the differences are due to the differences in the duration and the risks of loans. In general, the shorter the loan term and the fewer the risks (of only partial repayment, or non-repayment, or incurring costs to secure repayment), the lower the rate of interest. Examples of interest payments are those paid (or charged) by banking institutions on time deposits and for 'call money' lent to discount houses and for overdrafts to personal or commercial customers; by public authorities on central and local government securities and on other loans made to them, such as post office deposits; by institutions such as building societies and hire purchase finance companies; by companies on debentures', or in the form of dividend payments on ordinary shares

The math function of a raft of interest, as that of any other price, is to make the supply of loanable funds (i.e. the demand for securities) equal to their demand (supply of securities), and to 'ration' the supply among the demanders prepared to pay the price. Changes in demand or supply will cause changes in the rate of interest. If demand for a particular type of loan increases with no change in supply, or if supply decreases with no change in demand, the rate of interest will rise. But in a free market funds will tend to move from less to more profitable uses, and the original differences between the rates of interest for different types of loans will tend to be preserved. Changes in the rate of interest for one kind of loan will also tend to be reflected in similar changes in the rates for other kinds, so that rates of interest tend to change in the same direction throughout the economy. Some interest rates are not determined immediately by market forces; for instance, the rate for bank overdrafts is always above Bank rate, usually with 5 per cent as a minimum. Through 'cheap' or 'dear' money policies, government s can affect the general level of interest rates.

The supply of loanable funds consists of savings by individuals, businesses and institutions, (z) bank loans and advances and bank purchases of securities, (3) the excess of revenue over expenditure of public authorities. Individuals and businesses deciding to increase the supply of loans require also to decide whether (a) to spend less on goods and services, (b) to postpone repayment of debts, (c) to run down cash holdings. In general, the higher the cm-rent rates of interest the more the willingness to abstain from current consumption and to lend the savings rather than hold them as cash.

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