Interest can be said to be the price paid by the borrower for the use of funds saved by the lender and the compensation to the lender for his deferring expenditures. This compensation comprises two elements, namely a payment equal to the loss of purchasing power of the principal during the term of the loan and a balance that represents the real interest accruing to the lender. However this simplicity does not extend into the area of rate determination since rates vary not only because of inflation, as implied above, but also because of a number of other influences, including:
- The amount, purpose and period of the transaction;
- The credit-worthiness of the borrower;
- The collateral offered and/or other guarantees/guarantors available;
- The competition for the transaction;
- Government policy.
As a consequence, there will be numerous rates applying to the large number of transactions that are in effect at any one time in any one country. While efforts have been made in the rate selection to ensure as much international comparability as possible, the fact remains that the institutional features of each member’s financial markets are distinct and often markedly different from those of other members. However, the intent is to present for each country a range of rates, from ‘overnight’ through ‘short-term’ to ‘long-term’. In general, ‘overnight’ and ‘short term’ rates relate to money market instruments, while ‘long term’ rates are secondary market yields of long term (usually 10 year) bonds.