Thursday, October 17, 2013

Interest Rate

Interest Rate in simple words means the cost of borrowing funds. It is the payment we make to the lender for the facility of using his money for our own purpose. Many times our spending decisions are also guided by the interest burden that we would be bearing.

But, more than the returns we should be concentrating on real returns on our savings (real return = interest rate- inflation). Even as consumers, interest rate is an integral part of our spending habit as we borrow from the bank for buying house, cars, house old items etc. For the business community interest rate is also very important as they borrow money from bank for investment activities like capacity expansion, setting up of plants, acquisitions, modernization etc. So interest rates play a critical role in a business’s profitability and hence, on stock prices.

How many of us would invest in stock markets if our bank would pay 12% interest in fixed deposits? Many of us will prefer to deposit money in that bank than invest in stocks (as well as mutual funds). Why? Because, we have the opportunity to earn higher returns at very low risk. As a result, funds move out of stock market affecting the stock markets adversely.