Interest Rate

What is an Interest Rate?

The rate of interest is the amount charged on any debt by the creditor to the borrower. An interest rate is expressed in percentage points (%) or in basis points (bps), and is usually charged on an annual rate. The rate of interest charged will usually depend on the credit-worthiness or riskiness of the borrower. A high-risk borrower will be charged a higher rate of interest than a low risk borrower, all other things being equal. An example of interest rates is as follows:

  • An investor wishes to borrow $1,000,000 to invest in the stock market
  • A bank loans the investor $1,000,000 for 5 years at an annual rate of 5%
  • The investor has to pay $50,000 per year to the bank in interest as well as the $1,000,000 at the end of the 5 years
  • If the investor earns more than 5% per year, he will make a profit, otherwise he will lose money or break-even
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