Interest rate

The markets of interest rate are the gone of most important capital of the world, far in front of the foreign exchange market and very far in front of that of the action S, not only by treated volumes but also by their economic importance. It is usual to separate them in Money market for the short term and Bond market for the means and long run.

Definitions

The rate of interest of a Ready or a Emprunt is the percentage, calculated according to preset conventions , which measures in a synthetic way, on a period given, the Rentabilité for the Prêt or or the Coût for the borrower of the bill book of financial flows of the Prêt or the loan.

A loan, which by definition is the Prêt someone else, is a Contrat between two entities, whose Date S and amounts of the exchanged sums constitute the element Essentiel.

The concept of interest rate applies:

  • a priori with all the operations where one of the contracting parties is involved in debt, including financial Instruments which one generally describes by convention like products of saving (Savings account, obligation, etc);
  • also more generally a posteriori or by comparison with all the financial Instruments and Investment S, to measure of it the Profitability relative or absolute.
It thus occupies a central place in the operation of the modern economies…

For the neo-classic , interest rate is the Rémunération of the abstinence: that which ready gives up a immediate Consommation to save. Interest rate becomes the price of the Temps, the Récompense of waiting.

For Keynes, interest rate is the reward of the renunciation of the Liquidité. “It measures the loathing of the holders of Monnaie to alienate to them Droit to have which it constantly”. It leads the agents to arbitrate between active liquid (generally preferred) or placed (subject to remuneration).

Importance of conventions used

According to the conventions used, one will have for the same loan of appreciably different interest rates. Thus, by taking possible flows simplest, namely 100 refunded 102.50 one 92 days quarter later, which intuitively seems to correspond to approximately 10% in annual rate, one will have in fact over the period, by taking the principal European uses:

Even if, thanks to the universalization of the financial markets and, recently, thanks to the creation of the Euro, there were a real movement of standardization of the local practice, the number of methods and conventions of calculation of interest rates remains important. In France, for the intended products with the private individuals, which would be lost in this maquis, the legislator thus generally imposes the posting of the Annual percentage rate.

Principal types of rate

An interest rate can be:
  • fixes over all the duration of the loan

  • or variable . In this case it is generally indexed on:

  • or revisable (semi-variable): the indexing plays then in a limited way and by sections of duration, for example by annual periods.

  • or actuarial : it is the real output of the obligation according to its purchase price and the lifespan of the loan.

  • or facial : it is an interest rate defined in the emission and being used to calculate the amount of the coupon expressed as a percentage the nominal one.

Parameters of formation of the rates and organization of the markets of interest rate

A loan, let us recall it, is a contract, which is thus born from the common will of the contractors. It can thus be carried out in theory atany rate, even extremely far away from the rates used on the financial markets, in particular between private individuals, provided that the contracting parties are of agreement and that the legislation in force is respected, of which in France that which defines the wear.

Principal parameters

For the important amounts, there exist markets where intervene the banks, managers of funds and other financial institutions. The rates differ there according to various criteria specific to the lenders and the borrower, the three principal parameters being:
  • the nature of the instrument used (obligation, swap, Bank loan, etc)
  • duration (see Curve of rate and precedes Liquidité),
  • the risk of credit.

The curves of rate depend, they:

Directing markets

In the United States and in the Euro area, like, to a lesser extent, in Japan and in the United Kingdom, there exist permanently two markets of reference of interest rates from 0 to 30, even 50 years, of a very large liquidity  :
  • that of principal the Government loans   ;
  • that of the swap S against IBOR.
For interest rates of the other currencies, that is a little less true.

The market of the Government loans provides the curve of the interest rate without risk   ; that of the swaps, that of interbank interest rates.

For the short rates, the directing market is that of the swaps, via the future on IBOR   ; for those in the medium and long term, it is the market of the Government loans.

The rates of the Government loans are formed according to instantaneous supply and demand concentrated on the future ones on Government loans, like the contracts on Bunds of Eurex, which give rate/rhythm and direction to the other instruments.

Pricing of the rates

The valorization of an instrument of rate involving a credit risk (Ready, obligation, etc) is carried out in:
  • bringing up to date the bill book of financial flows of the instrument with the discount coefficients applicable to the Government loans;
  • by adding a to him premium of liquidity , i.e. an estimate of the cost of negotiation of the instrument;
  • and finally by adding a estimate expectation of the risk of defect of the borrower throughout loan. To evaluate it, one proceeds by comparison with the debt or, more and more, the Credit default swap S of the of the same transmitters notation.

The variation of annual percentage rate of which it is necessary to shift the curve of the Taux zero-coupon of the Government loans to lead to the price, noted on the market, of an instrument is commonly called spread rate of the instrument and is used to compare the relative values various instruments of rate. Before the generalization of the use of high power computers of calculation, one used simply the difference between the annual percentage rate of the instrument and that of a Government loan of close duration, but this method is rather vague and gradually tends to disappear.

Process of diffusion

Generally, and for all the markets of rate in the world, it is advisable to retain that rates:
  • is formed initially on the most liquid instruments, therefore generally of the futures when they exist;
  • and is diffused with the other instruments by two close processes:
    • English substitution (: switching ) i.e. the sale by the managers of funds of a credit which they have in stock and the purchase of another that they less expensive judge in relative value ;
    • the arbitration, to which the principle is close, but which is carried out ex nihilo , without stock, and on own account.

In addition, the arbitration rests, for the obligations, on the possibility of borrowing them, generally in Repo. Only a market where the loan/loan of titles is itself liquidates will be efficient. However nearly 90% of the rest take place either in dollar, or in euro…

Volumes

It is difficult to have an precise idea of the volumes negotiated overall on the markets of interest rate. The triennial study of the Banque of the international payments showed that in 2004, daily volumes of Derivative products of interest rate, and only them, were about 5.500 billion US Dollars. Taking into account different the Statistical scattered one has in addition, a daily total volume of about 8.000 billion US Dollars seems realistic.

As comparison, total daily volumes of the foreign exchange market were in 2004 of 1.900 billion US Dollars and those of the markets of actions and Market indexes of hardly a few hundreds of billion US Dollars.

Negative interest rates

Contrary to an generally accepted idea, interest rates - and not only the real Interest rate S, i.e. deducted rate of the inflation - can be negative very well.

See the article: negative Interest rates

See too

General concepts

Money market

principal Article: Money market

Bond market

principal Article: Bond market

Market of the Government loans

principal Article: Government loan

Market of the credit

Financial mathematics

principal Article: Mathematical financial

Derivative products

principal Article: Derived

Firm derivative products

Optional derivative products

principal Article: option

Actors of the markets of interest rate

External bonds

The specialized agencies (Bloomberg, Reuters, etc) as well as the platforms of trading of instrument of interest rate (MTS, Cantor Fitzgerald, etc) draw an important part of their incomes from the sale of quantitative information to the participants in the financial markets. Free information on the markets of rate is thus very little available on Internet.

Derivative products (accessible to the companies and any private or public organization since it manages an important amount of debt or trésorie), are negotiable near the banks. Nevertheless, in order to obtain a council specialized and impartial on the arbitrations to realize, it is possible to pass through a consultancy in risk of rate, independent of any bank or any organization parabancaire.

  • Calculation of damping

Interest rate of the euro area: daily statements at Paris 11:00, time

  • Euribor
  • Annual percentage rate of the swaps, 1 to 30 years, against Euribor 3 months
  • TEC10: annual percentage rate of a theoretical OAT of expiry 10ans
  • Rate IRS
  • legal Interest rate

American interest rates

  • Database of the EDF - Attention, conventions heterogeneous

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