Interest rate

An interest rate is the amount of interest due per period, as a proportion of the amount lent, deposited, or borrowed. Interest rate periods are ordinarily a year and are often annualized when not. Alongside interest rates, three other variables determine total interest: principal sum, compounding frequency, and length of time.

Interest rates reflect a borrower's willingness to pay for money now over money in the future. In debt financing, companies borrow capital from a bank, in the expectation that the borrowed capital may be used to generate a return on investment greater than the interest rates. Failure of a borrower to continue paying interest is an example of default, which may be followed by bankruptcy proceedings. Collateral is sometimes given in the event of default.

In monetary policy and macroeconomics, the term "interest rate" is often used as shorthand for a central bank's policy rate, such as the United States Federal Reserve's federal funds rate. "Interest rate" is also sometimes used synonymously with overnight rate, bank rate, base rate, discount rate, coupon rate, repo rate, prime rate, yield to maturity, and internal rate of return.

The nominal interest rate is the interest rate without adjusting for inflation, whereas the real interest rate takes inflation into account. Real interest rates measure the interest accumulated and repayment of principal in real terms by comparing the sum against the buying power of the amount at the time it was borrowed, lent, deposited or invested. Where inflation is the same as nominal interest rate, the real interest rate is zero.

The real interest rate is given by the Fisher equation:

where p is the inflation rate.

For low rates and short periods, the linear approximation applies:

The Fisher equation applies both ex ante and ex post. Ex ante, the rates are projected rates, whereas ex post, the rates are historical.