You will find a lot of information about the history of money and the details of interest in My Economy Guide and you can easily learn the information mentioned in this content written in a very simple expression. Before examining the concepts of money and interest, we recommend that you read our article Economy and Trade .
WHAT IS SWAP?
In the days before the invention of money, people would give the products they had to meet their needs and get the products they wanted in return. The name of this exchange system is swap . This method, which is widely used in the periods before money, is not completely lost in today’s conditions.This method has a major disadvantage. If you want to buy goods from your neighbor through the exchange method, your neighbor will also need or require the goods and products you will receive from you. In other words, both parties can exchange goods or goods if they want to be given by the other party. This is called a mutual overlap of needs .
DEVELOPMENT OF MONEY
As a result of the inadequacies of the exchange system, cultures have invented money in different times and geographies. Many materials such as salt, tobacco, precious metals, stones, leather and seashells have been used as money in human history.
Minerals, metals, gold and silver coins and agricultural products used in trade are used as commodity currencies . Commodity money is not the only purpose of use as money. This is also seen as an advantage of commodity coins.
The most important factor in the formation of representative money was the use of it as an alternative to commodity money. As a result of the difficulty of using gold as money, receipts were started to be cut by the amount of gold and these receipts were used to represent the gold in the purchase and sale business.
The use of representative money has greatly facilitated the transition of people into irrevocable nominal money, such as dollars, pounds, and yen. Irrevocable nominal money is in fact worthless and unsupported by commodities. The government has told us that this is money, and we have accepted it as money.
According to economists, the value of money is affected by time. Over time inflation decreases the purchasing power of this money and reduces its value. The money you give to your brother will be worthless when you get it back, and there will also be an opportunity cost for not being able to use it during your stay. This opportunity is used interest to reduce the cost and the impact of inflation .Interest is basically a kind of payment made for the use of a certain amount of money. The interest rate is the price that determines this payment amount. There are many factors that make up this price. Now let’s examine the concepts that affect the interest rate.
BASIC INTEREST RATE
This rate reflects the opportunity cost incurred because your money is unavailable. In more terms, the rate that equates the level of borrowing with the saving level when there is no risk of inflation or risk is the basic interest rate. For example, if you give up your money with 1.5% interest rate, this 1.5% rate is accepted as the basic interest rate.
EXPECTED INFLATION RATE
The basic interest rate will cover your opportunity cost while inflation will depreciate your money. Therefore, this rate is used against the expected cost of inflation. For example, if you take certain certainty that inflation will be 3% in your location, your investor or lender will add the expected inflation rate to the basic interest rate and your nominal interest rate will be 4.5%.
PRECAUTIONS FOR RISK
The default risk is also taken into account if there is a possibility that the loan or investment will have bad consequences. The greater the probability of non-payment or the risk of default, the higher the total interest rate. A customer who owns the debt and does not disrupt the debt on time will have a lower interest rate in total than the other customer who has delayed the debt and has problems in paying the debt.
If a loan or investment will take a long time to make a profit and it will be very difficult to make a profit, an extra interest rate comes into play. Because while it is important to make gains in credit transactions, loans used for non-liquid commodities remain weak in terms of earnings. To summarize, loans used for goods that are difficult to convert into cash require a higher interest rate than normal conditions.
Maturity Risk Premium
The possibility of an increase in interest rates as time passes creates the risk of maturity. In this case, an additional interest rate is added to ensure that the income to be provided does not remain lower than normal. In other words, in the future, higher income will be obtained due to the increase in interest rates from a similar investment and less profit will be obtained from the investment without maturity risk. Thus, this situation is prevented with maturity risk premium.To sum up our examples, our basic interest rate was 1.5%. The expected inflation rate is added to 3% and our nominal interest rate is 4.5%. If 3% for default risk premium, 2% for liquidity premium and 1% for maturity risk premium are taken as an example, these rates are added to our interest rate of 4.5% and our total nominal interest rate of 10.5% arises.