Interest Rate Concepts and Calculations Flashcards
Define “negative interest rate”
An interest rate that is below zero (i.e. < 0.0%). The flow of benefit payment (interest) is reversed so that a financial institution charges depositors to hold their money on deposit.
Define “term structure of interest rates.”
Describes the relationship between long-term interest rates and short-term interest rates. Commonly plotted with interest rates on vertical axis and time on horizontal axis.
Define “annual percentage rate (APR).”
The annualized effective interest rate (without compounding) on loans that are a fraction of a year. In effect, the effective interest rate for a portion of a year is “grossed up” to an annual rate.
Computed as the effective interest rate for the fraction of a year multiplied by the number of such fractions in a whole year.
Basis of interest rate disclosure in U.S.
Define “interest.”
Cost of the use of money. It is expressed as a percentage rate, almost always as an annual percentage rate, and applied to the principal to determine dollar amount.
Define a “fixed interest rate.”
The percentage rate of interest does not change over the life of the loan or parts of that life.
Define “effective interest rate.”
The annual interest rate implicit in the relationship between the net proceeds of a borrowing (or other arrangement) and the dollar cost of the borrowing (or other arrangement).
Computed as: Dollar cost of borrowing / Net proceeds of borrowing.
Define a “variable interest rate.”
The percentage rate of interest can change over the life of the related debt instrument.
Define “stated rate (of interest)” (also used interchangeably with “nominal rate” or “quoted rate”).
The annual rate of interest specified in a debt instrument or other contract/agreement; it does not take into account the compounding effects of payment frequency.
Define “simple interest.”
Interest computed on the principal only; there is no compounding in the interest computation (i.e., no interest paid on interest).
Define “compound interest.”
Interest computed not only on the principal but also on any accumulated unpaid interest (i.e., interest is paid on interest).
Define “effective annual percentage rate” (also called the “annual percentage yield”).
Annual interest rate with compounding on loans that are for a fraction of a year.
