Interest rates are the price of borrowing money. They exist because lenders need compensation for taking the risk that borrowers may default. When interest rates rise, it means borrowing costs are higher and stock markets often drop as economic growth could slow. Interest rates are influenced by factors like the level of inflation, term of the loan, and risk of default. Central banks aim to keep rates at a level that promotes healthy economic growth without spurring too much inflation.

1. INTEREST RATES

2. INTEREST RATES
You're watching the news and they're talking about a recent
announcement from RBI, in which it is hinted that the interest
rates may be raised in the next week.
The stock market drops the next day.
Why?

3. INTEREST RATES
How Do Interest Rates Work
Before you get all worked up, you should know that interest rates
aren't evil.
They're the price of living in a world that relies heavily on credit
and debt.
If interest rates didn't exist, lenders would have no reason to let
you borrow money.

4. INTEREST RATES
And if you couldn't borrow money, you could never buy a house
or a car, or enjoy many of the other advantages of life with credit,
like buying air tickets and paying bills online with a credit card.

5. INTEREST RATES
In this lesson, I'll help you
understand why interest rates
exist, how they're calculated
and why they change over time.

6. INTEREST RATES
An interest rate is the cost of
borrowing money.
A borrower pays interest for the
ability to spend money now,
rather than wait until he's saved
the same amount.

7. INTEREST RATES
For example, if you borrow `100 at an annual interest rate of
five percent, at the end of the year you'll owe `105.
But interest rates aren't just random punishments for
borrowing money. The interest a lender receives is his
compensation for taking a risk.
How?

8. INTEREST RATES
With every loan, there's a risk that the borrower won't be able
to pay it back.
The higher the risk that the borrower will default (or fail to
repay the loan), the higher the interest rate.
That's why maintaining a good credit score will help lower
the interest rates offered to you by lenders.

9. INTEREST RATES
The nice thing is that interest rates work both ways.
Banks, governments and other large financial institutions need cash
too, and they're willing to pay for it.
If you put money into a savings account at a bank, the bank will pay
you interest for the temporary use of that money.

10. INTEREST RATES
Governments sell bonds and other securities for the same reason.
In this case, you're the lender to the government and the interest rate
is your compensation for temporarily giving up the ability to spend
your cash.
But remember, savings accounts and government-issued bonds pay
relatively low interest rates because the risk of their defaulting is
close to zero.

11. INTEREST RATES
You should also know that interest rates for unsecured credit will
always be higher than secured credit.
Secured credit is backed by collateral. A home
loan is a classic example of secured credit, because if the
borrower defaults on the loan, the bank can always take the
house.
Credit cards are unsecured credit, because there's no collateral
backing the loan, only the cardholder's credit score.

12. INTEREST RATES
Long-term loans also carry higher interest rates than short-term
loans, because the more time a borrower has to pay back a
loan, the more time there is for things to possibly go bad
financially, causing the borrower to default.

13. INTEREST RATES
Another factor that makes long-term loans less attractive to
lenders -- and therefore raises long-term interest rates -- is
inflation.
In a healthy economy, inflation almost always rises, meaning the
same rupee amount today is worth less five years from now.
Lenders know that the longer it takes the borrower to pay back a
loan, the less that money is going to be worth.

14. INTEREST RATES
That's why interest rates are actually calculated as two different
values: the nominal rate and the real rate.
The nominal rate is the interest rate set by the lending institution.
The real rate is the nominal rate minus the rate of inflation.

15. INTEREST RATES
For example, if you take out a
home loan with a nominal interest
rate of 10 percent, but the annual
rate of inflation is four percent,
then the bank is only really
collecting six percent on the loan.

16. INTEREST RATES
So how do interest rates affect the rise and fall of inflation?
Well, lower interest rates put more borrowing power in the
hands of consumers. And when consumers spend more, the
economy grows, naturally creating inflation.

17. INTEREST RATES
If the RBI decides that the economy is growing too fast-that
demand will greatly outpace supply-then it can raise interest
rates, slowing the amount of cash entering the economy.
So there must be enough economic growth to keep wages up
and unemployment low, but not too much growth that it leads to
dangerously high inflation.

18. CURRENT ACCOUNT DEFICIT
INTEREST RATES
Let us see the formula of the Current Account Balance (CAB)
CAB = X - M + NI + NCT
X = Exports of goods and services
M = Imports of goods and services
NI = Net income abroad [Salaries paid or received,
credit / debit of income from
FII & FDI etc. ]
NCT = Net current transfers
[Workers' Remittances
(unilateral), Donations, Aids &
Grants, understood the concept
Hope you have Official, Assistance and
of Interest Rates.
Pensions etc]

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20. DISCLAIMER
The lesson is a conceptual representation and may not
include several nuances that are associated and vital. The
purpose of this lesson is to clarify the basics of the concept
so that readers at large can relate and thereby take more
interest in the product / concept. In a nutshell, Professor
Simply Simple lessons should be seen from the perspective
of it being a primer on financial concepts.
Mutual Fund investments are subject to market risks, read
all scheme related documents carefully.