Interest Rate
The interest rate is the price of money over time --- the cost of borrowing, the reward for lending, and the signal that connects savers and borrowers across the economy.
What is it?
An interest rate is the percentage charged by a lender to a borrower for the use of money over a period. It is the practical expression of the time-value-of-money: since a franc today is worth more than a franc tomorrow, the borrower must compensate the lender for surrendering the use of their money.1
Interest rates encode three things simultaneously: the time preference of the lender (compensation for waiting), the inflation expectation (compensation for purchasing power erosion), and the risk of default (compensation for the possibility that the borrower does not repay). This is why a Swiss government bond pays less than a corporate bond, which pays less than a personal loan, which pays less than a credit card.
In plain terms
An interest rate is the rental price of money. You rent someone else’s money for a while, and the interest is the rent. The riskier you look as a tenant, the higher the rent.
How does it work?
Central bank rates set the floor
The Swiss National Bank (SNB), like all central banks, sets a policy rate --- the interest rate at which commercial banks can borrow from the central bank. This rate propagates through the entire economy: it influences mortgage rates, savings rates, bond yields, and business lending costs.
When the central bank lowers rates, borrowing becomes cheaper --- encouraging spending and investment. When it raises rates, borrowing becomes more expensive --- slowing the economy and containing inflation. This is monetary policy: steering the economy through the price of money.
Real vs nominal rates
The nominal rate is the stated rate. The real rate is the nominal rate minus inflation. If your savings account pays 2% and inflation is 1.5%, your real return is 0.5%. If inflation is 3%, your real return is negative --- your money is losing purchasing power despite earning interest.
Real rates are what matter for wealth building. A 5% return in a 4% inflation environment (1% real) is worse than a 3% return in a 0.5% inflation environment (2.5% real).
Impact on your financial life
- Savings: Low rates mean cash earns nothing. This is why investing (accepting risk for return) becomes necessary.
- Mortgages: Rate changes of 1% on a CHF 500K mortgage change annual payments by ~CHF 5,000.
- Bonds: When rates rise, existing bond prices fall. When rates fall, existing bond prices rise.
- 3a and pensions: Low rates reduce the projected returns of pension funds, potentially affecting future payouts.
Check your understanding
Five questions (click to expand)
- Explain what an interest rate encodes (time preference, inflation expectation, default risk). Why does a mortgage have a lower rate than a credit card?
- Calculate the real interest rate if nominal rate is 3.5% and inflation is 2%. Why does this matter more than the nominal rate?
- Describe how central bank policy rates propagate through the economy. What happens when the SNB raises rates?
- Connect interest rates to bond prices. Why do they move inversely?
- Apply interest rate analysis to your mortgage or savings. How would a 1% rate change affect your finances?
Where this concept fits
Where this concept fits
graph TD TVM[Time Value of Money] --> IR[Interest Rate] CT[Credit and Trust] --> IR IR --> INF[Inflation] IR --> AC[Asset Class] IR --> CS2[Capital Structure] style IR fill:#4a9ede,color:#fff
Sources
Footnotes
-
Fisher, I. (1930). The Theory of Interest. New York: Macmillan. The foundational work on interest as the price of time. ↩