chapter  2
15 Pages

Interest rates and financial markets

Interest rates represent prices of every economic action because they represent both opportunity costs for the use of goods, services and inputs and connect time periods to each other. The sacrifice of consumption today must come with a reward, and consuming today must have its cost. There are many interest rates, one for every asset that exists. The “price” of an asset is in part determined by an interest rate. Interest rates are used in business plans to discount the future, as income to those who have deposited money, purchased stocks and bonds, and to those who make a loan. It is a cost to those who borrow, the cost of consuming more than you can afford at a given time. It is also the cost of not buying something that could produce income. We can summarize the interest rate’s definition generally in four ways:

• The revenue from lending or not consuming; • The cost of borrowing or consuming; • The opportunity cost of holding money as cash; and • A measure of time preference concerning consumption.