The interest rate is the price charged a borrower for the loan of money. This price is unique because it is really a ratio of two quantities: the total required fee a borrower must pay a lender to obtain the use of credit for a stipulated time period divided by the total amount of credit made available to the borrower. By convention, the interest rate is usually expressed in percent per annum. Thus,
For example, an interest rate of 10 percent per annum on a $1,000, one-year loan to purchase a computer implies that the lender of funds has received a borrower’s promise to pay a fee of $100 (10 percent of $1,000) in return for the use of $1,000 in credit for a year. The promised fee of $100 is in addition to the repayment of the loan principal ($1,000), which must occur sometime during the year. Interest rates are usually expressed as annualized percentages, even for financial assets with maturities shorter than a year. For example, in the federal funds market, banks frequently loan reserves to each other overnight, with the loan being repaid the next day. Even in this market the interest rate quoted daily by lenders is expressed in percent per annum, as though the loan were for a year’s time. However, various types of loans and securities display important differences in how interest fees and amounts borrowed are valued or accounted for, leading to several different methods for determining interest rates. Some interest rate measures use a 360-day year, while others use a 365-day year. Some employ compound rates of return, with interest income earned on accumulated interest, and some do not use compounding.