Interest

INTEREST
Interest measures the cost of borrowing money from a lender and is usually expressed as an annual percentage of the principal.

Interest is usually paid only on the principal, that is, on the sum of money loaned, and it is called simple interest. In some cases, interest is paid not only on the principal but also on the cumulative total of past interest payments. This procedure is known as compounding the interest, and the amount so paid is called compound interest.

The rate of interest is expressed as a percentage of the principal paid for its use for a given time, usually a year. Thus, a loan of $100 at 10 percent per annum earns interest of $10 a year. The current, or market, rate of interest is determined primarily by the relation between the supply of money and the demands of borrowers .

When the supply of money available for investment increases faster than the requirements of borrowers, interest rates tend to fall. Conversely, interest rates generally rise when the demand for investment funds grows faster than the available supply of funds to meet that demand. Business executives will not borrow money at an interest rate that exceeds the return they expect the use of the money to yield.

Interest costs depends on the inflation rate, the credit risk of the borrower and the time value of money.