Interest Rate

An interest rate is the price of money — what borrowers pay to use someone else's capital, and what lenders/savers earn for providing it. Expressed as an annual percentage, interest rates are the single most important variable in finance, affecting everything from mortgage payments to stock valuations to currency exchange rates.

The most influential interest rate in the U.S. economy is the federal funds rate, set by the Federal Reserve (the Fed). This is the rate at which banks lend to each other overnight, and it cascades through the entire financial system. When the Fed raises rates, borrowing becomes more expensive across the board — mortgages, car loans, credit cards, and business loans all cost more. When the Fed cuts rates, borrowing becomes cheaper, stimulating economic activity.

Key Interest Rate Types:

Rate Type	Who Sets It	What It Affects
Federal Funds Rate	Federal Reserve	All other rates (benchmark)
Prime Rate	Banks (Fed + 3%)	Credit cards, HELOCs, business loans
10-Year Treasury	Bond market	Mortgages, corporate bonds
Mortgage Rate	Lenders	Home buying affordability
Savings/CD Rate	Banks	Returns on deposits
Corporate Bond Yield	Market	Cost of corporate borrowing

How Interest Rates Affect Asset Classes:

Asset	Rising Rates Impact	Falling Rates Impact
Bonds	Prices fall (yields rise)	Prices rise (yields fall)
Stocks (Growth)	Valuations compress significantly	Valuations expand
Stocks (Value)	Relatively resilient	Moderate benefit
Real Estate	Prices often decline (higher mortgages)	Prices often rise
Cash/Savings	Higher yields on deposits	Lower yields
Gold	Mixed — depends on real rates	Generally positive
USD Currency	Strengthens (attracts foreign capital)	Weakens

The Relationship Between Rates and Bond Prices:

Bond prices and interest rates move inversely. When rates rise, existing bonds with lower coupon rates become less attractive, so their prices fall. The sensitivity is measured by duration — a bond with 10-year duration loses approximately 10% of its value for every 1% rise in rates.

Real vs. Nominal Interest Rates:

• Nominal Rate: The stated rate (e.g., 5% savings account)
• Real Rate: Nominal rate minus inflation (e.g., 5% - 3% inflation = 2% real return)
• Negative Real Rates: When inflation exceeds the nominal rate — savers lose purchasing power even while earning interest

Historically, the average fed funds rate has been approximately 4.5%–5%. The extended period of near-zero rates (2009–2021) was historically abnormal and contributed to inflated asset prices across stocks, real estate, and bonds.