Download What is Interest? Interest is _____the price that someone pays for

Math of Finance
Interest Rates
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Name:____________________
What is Interest?
Interest is _____the price that someone pays for the temporary use of someone else’s funds
______________________.To repay a loan, a borrower has to pay interest, as well as the principal,
the amount originally borrowed. Interest is the compensation that someone receives for
__________temporarily giving up the ability to spend money__________. Without interest,
lenders wouldn’t be willing to lend, or to temporarily give up the ability to spend, and
savers would be less willing to defer spending. Interest rates are expressed as
_________percents per year__________. If the interest rate is 10 percent per year, and you
borrow $100 for one year, you have to repay the $100 plus $10 in interest. Because interest
rates are expressed simply as percents per year, we can compare interest rates on different
kinds of loans, and even interest rates in different countries that use different currencies
(yen, dollar, etc.).
What are "APR" and "APY"?
"APR" stands for "___annual percentage rate_____," and "APY" for "_______annual percentage
yield______."
APR is the annual rate of interest without taking into account the compounding of interest
within that year. Alternatively, APY does take into account the effects of intra-year
compounding.
Why Does Interest Exist?
From the lender’s point of view:
Interest compensates lenders for the effects of __inflation__, or rising prices. Prices
go up every year, so lenders are repaid with dollars that can’t buy as much as the
dollars they lent; the lenders must be compensated for that loss of ____purchasing
power_____.
Interest also compensates lenders for the ______risks they take_____. One risk is that
nobody knows for certain how much prices will go up during the time that the
borrower has the lender’s money. Other risks are that the borrower won’t repay the
loan fully, on time, or at all.
For a lender such as a bank, interest covers _________the cost of staying in
business_____ ___________________, including the cost of processing loans, and interest
also provides the profit that a lender needs to stay in business.
From the borrower’s point of view:
Individuals are willing to pay interest to borrow money in order to __________________
_____be able to spend now, rather than later______ on cars and many other items.
Individuals are willing to pay interest in order to be able to afford a large purchase,
such as a home, for which they don’t have enough funds of their own.
Individuals are willing to pay interest on loans to pay for education, which can
increase their earning ability.
Businesses are willing to pay interest in order to borrow to invest in equipment,
buildings, and inventories that will increase their profits.
Some borrowers are willing to pay interest on certain loans because of the
associated ___tax_____ advantages. Mortgage interest, for example, is tax deductible.
That means that in calculating how much income tax you have to pay, you can
subtract the mortgage interest that you pay from your income.
Banks are willing to pay interest on their customers’ deposits because they can
___________lend the funds at higher interest rates__________________ and make a profit.
Interest: Cost to Some, Income to Others?
Interest is income to people willing to __________give up the temporary use of their
money________. When you put money into a bank account, or when you buy a U.S. Savings
Bond, for example, you receive interest income.
Interest is a cost to ______borrowers_______. You pay interest, for example, if you don’t pay
your entire credit card bill at the end of the month, if you take out a mortgage loan to buy a
house, or if you own a business that borrows in order to invest in machinery.
Interest is a signal that directs funds to where they can earn the highest rates, or to where
loans can do the most for the economy.
Interest is a measure of _____________the cost of holding money___________________. The rate of
interest that you could earn by lending your money is the cost to you of holding your
money in a way (such as in cash) that doesn’t earn any interest. Economists use the term
"_______opportunity cost_______" to refer to what you give up by choosing a certain course of
action. By holding money, you give up the interest that you could have earned, so the
interest rate measures the ___________opportunity cost________ of holding money.