## Changes in Interest Rates

An activity that looks at external influences for Level 2.

# Level 2 Business and Economics: External Influences

## Changes in Interest Rates

An interest rate is the price of acquiring a loan. Businesses of all sizes borrow money, often from banks, to help finance their activities. Banks are effectively using someone else's money to lend to you, the business. As a result, the bank imposes a charge for the privilege - this charge is the interest.

The interest rate is usually expressed as a percentage. If a firm borrowed £100,000 over a five year period (that means they have five years to pay back the £100,000) at an interest rate of 10%, then the firm will have to pay back £ 10,000 a year in interest to the bank.

There are some terms to remember when looking at loans.

• Principal (p) - this is the amount of the loan - the amount of money borrowed.
• Rate of Interest (r) - the rate of interest that the borrower has to pay, expressed as a percentage.
• Time (t) - the time period of the loan: some loans might be taken out over a few days or months, others over many years.
• Interest (I) - the total amount of interest to be paid on the loan.

The formula for calculating simple interest is:

I = p x r x t

So, if I wanted to borrow £5,000 from a bank over a period of 2 years, at an interest rate of 5%, the total interest I would have to pay would be:

• I = 5,000 x 5% x 2. (5% = 5/100, which equals 0.05)
• I = 5,000 x 0.05 x 2
• I = £500.

The monthly interest payment, therefore, would be £500 / 24 = £20.84. The total paid back to the bank would be £5,500.