Interest rate has a key role in every transaction over the world. In fact, many business enterprises encounter complicated decision when they are considering the refinancing of a substantial loan. They sometimes confuse whether to borrow at variable rate of interest rate or to borrow at fixed rate of interest rate. Consequently, this paper attempts to summarize the factors determining movements in the general level of interest rates.
The definition of Interest rate is ÃÂthe percentage yield on a financial security such as a bond or a shareÃÂ (McTaggart et all, 1999, P690). It is the amount of money which must be paid for the use of one dollar for one year. There are five factors determining the level of interest rates: ÃÂ the productivity of capital goods and the time preference of savers, expectations concerning interest rates and inflation, the demand for money, monetary policy, and international interest rate levelsÃÂ (Stegman & Junor, 1993, P203).
The first factor that leads to fluctuation in nominal interest rate is the productivity of capital goods and the time preference of savers. Since the higher interest rate, the smaller is the number of prospective capital investments, the demand for loanable funds is negatively related to the interest rate. However, the supply of loanable funds from saving has positive relationship with interest rate. In terms of consumerÃÂs time preference, there is a difference between current and future consumption related to interest rate. The higher interest rate, the higher the opportunity cost of current consumption (foregone interest on savings) and vice versa.
Secondly, the general level of interest rates could be strongly influenced by market expectations. This is related with bonds, which is defined as ÃÂa legally enforceable obligation to pay specified sums of money at specified future datesÃÂ (McTaggart et al, 1999, P:G.2). If...