In the world of banking, one of the terms that are often heard and important to know is interest rates.

In simple terms, bank interest rates are a form of adjustment (reward) in the form of funds (money) to customers from the bank.

As for the crypto world, interest rates also have an important role because they greatly impact the market and investors.

The influence can be seen from the price of crypto assets, the volatility of the crypto market, borrowing costs and leverage, as well as long-term investment decisions in the crypto world.

On the other hand, interest rates can also be the cost of borrowing or investing because they reflect the added value of the loan or investment amount.

In this case, the interest rate is a cost that must be limited by investors when investing.

So, to better understand what interest rates are, types, functions, and the differences from Annual Percentage Yield (APY), consider the following review.

General Types of Interest Rates

In finance and investment, understanding the types of interest rates, in general, is very important.

That’s because this understanding will have an impact on the financial decisions of a person or company.

Choosing the right type of interest rate in line with your needs and risk profile will help individuals or companies make the right financial decisions.

The following are general types of interest rates that you need to know, including:

1. Fixed Interest Rate

As the name implies, this type of interest rate is fixed and does not change until maturity.

Examples can be seen in the interest rates for housing loans (KPR), subsidized housing, and used in motor vehicle loans.

2. Fiat Interest Rate

This type of interest rate is a type of interest rate with a calculation that refers to the principal loan amount at the beginning of each installment period.

Calculating it is also very simple compared to other types, and because of that, it is widely used for short-term loans.

3. Annuity Interest Rate

In this type of annuity interest rate, it is arranged that the total principal installments plus the interest installments paid are the same per month.

As for calculating this type of interest rate, the initial interest portion is substantial, while the principal installment portion is very small.

However, the situation changed when the credit period was about to end; the principal portion repaid in installments would be large, while the interest portion would be very small.

4. Effective Interest Rate

The type of effective interest rate is the interest rate calculated from the total remaining principal loan each month in line with the reduced amount of debt that has been repaid.

In the sense that the smaller the principal loan amount, the smaller the interest rate that must be killed.

5. Floating Interest Rate

Finally, there is a floating interest rate on this list, which is a type of interest rate that always changes as interest rates change in the market.

Related to this, if market interest rates rise, this interest rate will also rise and vice versa.

Interest Rate Function

As with the types of interest rates, in context, the function of interest rates is also very important to understand.

The reason is that with a good understanding of the function of interest rates, a person or company can manage borrowing costs properly.

In addition, a person or company will also be able to make the right investment decisions after understanding the function of interest rates.

The following are several functions of interest rates that need to be known, including:

1. Be an unequal result

The first function of the interest rate is to be as well as to balance the yield for the lender.

In this case, the interest rate is a buyer that investors get as an imbalance related to the use of their funds and the risks they take.

In addition, interest rates also increase the risk investors take, which can impact investment decisions.

2. Into the cost of borrowing

The next function of the interest rate is as a borrowing fee. Related to that, the interest rate is the interest rate that must be paid with a loan to the lender as payment for the use of the funds earlier.

In this case, the interest rate will also impact the overall loan cost, installment amount, and loan eligibility.

3. Become a customer attraction

Another function of the tribe is to attract customers. Therefore, the interest rates offered by financial institutions can impact customer decisions regarding selecting financial products or services.

Meanwhile, offering competitive interest rates for financial institutions will attract customers and expand the institution’s market share.

4. Control the money in circulation

Meanwhile, the next function of interest rates is as a tool to control the amount of money in circulation.

This is because the central bank determines the interest rate, which can be on the level of demand for and supply of money in a country.

How to Calculate Interest Rates

How to calculate interest rates is important for anyone to understand.

This is because interest rates will always be related to personal and business financial management.

Thus, this way of calculating interest rates will help make better financial decisions.

Here are some ways to calculate interest rates that you need to know, including:

1. Based on daily balance

First, there is a way to calculate interest rates based on daily balances in the current month’s period on account mutations. The formula is:

Interest = daily balance x savings interest rate x difference in days / 365 days

2. Based on the lowest balance

The second method of calculating interest rates is based on the lowest balance.

The method looks at the lowest balance in an account mutation period.

In addition, it is also important to underline that the number of interest rates according to this indicator can vary. Here’s the formula to calculate it:

Interest = lowest balance x (interest rate x total days in a month) / 365 days

3. Based on the average balance

Furthermore, how to calculate interest rates can also be based on the average balance. Here is the formula:

Interest = average balance x (savings interest rate x total days in a month) / 365 days

Difference between Interest Rate and APY (Annual Percentage Yield)

Understanding the difference between interest rates and APY (Annual Percentage Yield) is also important.

This is related to managing finances and making the right investment decisions.

By understanding the difference between the two, you can estimate profit.

The APY is a measure used to calculate the actual profit of a financial product (savings/investment), considering the effect of compound interest (interest).

In short, APY is a percentage that describes the profit that will be achieved from a financial product in one year.

Annual Percentage Yield or AYP is also different from interest rates. The reason is the interest rate is a percentage that describes the cost of borrowing / desired return on investment.

In addition, it is known that interest rates do not calculate the effect of compound interest.

Therefore, the result will remain the same over a certain period in a product with a fixed interest rate.

Meanwhile, for products with APY, it is known that the results will always grow in line with the compound interest effect.

It should also be noted that compounding is an important concept in APY and has a major influence on the crypto world.

APY itself includes the effect of interest related to the calculation of the actual profit of a financial product.

In the crypto industry, compounding has been applied through DeFi (Decentralized Finance) and several products, including staking, lending, and yield farming.

Applying this interest in the crypto world will allow crypto-asset owners to increase their investment.

In addition, by applying interest rates, crypto holders can also utilize higher growth potential than traditional financial products.

Conclusion

In conclusion, in a financial context, the function of interest rates is very important to understand.

The reason is that with a good understanding of the function of interest rates, a person or company can manage borrowing costs properly.

In addition, a person or company will also be able to make the right investment decisions after understanding the function of interest rates.

Meanwhile, APY is a measure used to calculate the actual profit of a financial product (savings/investment), considering the effect of compound interest (interest).

In short, APY is a percentage that describes the profit that will be achieved from a financial product in one year.

So, that was the complete discussion about interest rates, from their types and functions to how to calculate them.

Furthermore, you can also read other interesting articles, such as deflation to derivatives, only at INDODAX Academy.