What Is an Interest Rate?
An interest rate is the price of money over time, quoted as a percentage per year. It decides what a future payment is worth today, what a borrowed position costs to hold, and what holding cash instead of an asset gives up.
Interest rates get reported as news, which makes them look like an opinion about the economy. They are better understood as a conversion factor: the number that turns money arriving later into money worth something now.
How it works
Money now is worth more than the same money later, because money now can be lent, invested or spent. The interest rate is the price of that difference, quoted per year.
Every asset is a claim on money arriving later. A bond pays coupons; a company produces earnings; a property produces rent. Valuing any of them means converting those future amounts into today’s money, and the interest rate is the converter.
So a rate change reprices everything at once, without anything about any individual asset having changed. That is why a single announcement moves markets that appear to have nothing to do with one another.
Why duration decides the damage
The further away the money is, the more the conversion factor matters. A payment due next year is barely affected by a change in the rate. A payment due in thirty years is affected enormously, because the rate is applied thirty times over.
This is the whole reason some assets are called rate-sensitive and others are not. It is not a property of the industry or the story — it is a property of how far in the future the money sits.
And there is no single rate. There is a rate for overnight money, for two-year money, for thirty-year money, and they move independently. “Rates went up” is a headline, not a measurement.
A worked example
Use this site’s own measurement of what a small annual percentage does over a long horizon. The fee study on this site measured the drag of an annual charge across thirty years: 5 basis points costs 1.5% of the final balance, 20 basis points costs 5.8%, 75 costs 20.2%, and 150 costs 36.5%.
That is the same arithmetic an interest rate runs, in the other direction. An annual percentage, applied repeatedly over thirty years, is not thirty times itself — it compounds, and the gap between a small rate and a slightly larger one widens the whole way.
Read the numbers again as rates rather than fees. The step from 0.05% to 1.50% a year is small in any single year and worth 35 percentage points of the final amount across thirty. Nothing about that requires a dramatic move; it requires only time and repetition.
And it changes what holding cash costs. When the rate is near zero, cash gives up almost nothing. When it is meaningfully positive, every day in cash is a day of forgone return — and every day in an asset is a day of forgone interest. The comparison runs both ways.
Which rate applies depends on the horizon of the thing being valued. A company’s near-term earnings are discounted at a short rate and its distant ones at a long rate, so a curve that steepens changes the valuation even when the headline rate has not moved at all. That is why “rates are unchanged” and “every long-dated asset repriced” can both be true on the same day.
What it costs a trader directly
A leveraged position is borrowed money, so the rate is charged on it every night. That cost is applied to the full position size rather than the deposit, which is why it accumulates faster than most people expect on a position held for weeks.
It is charged whether the trade is winning or losing, which puts it in the same category as the spread: a cost that is indifferent to whether your judgement was any good.
The original data
This site’s fee measurement over thirty years: 5 basis points a year costs 1.5% of the final balance, 20 costs 5.8%, 75 costs 20.2%, 150 costs 36.5%.
The relationship is not linear and that is the finding. Tripling the annual percentage from 5 to 20 basis points nearly quadruples the cost. Doubling again from 75 to 150 raises it from a fifth of the balance to well over a third.
Applied to interest rather than fees, the same curve describes borrowing. A position financed at a low rate and the identical position financed at a high one are different trades, and the difference grows with every night held.
When it fails
The characteristic failure is treating a rate move as a directional signal. A cut is read as good news and a rise as bad, and both readings skip the part that matters — the rate is an input to a valuation, not a verdict on one. Whether an asset rises on a cut depends on what else moved at the same time, what was already priced in, and how far in the future its money sits. Trading the headline means acting on the announcement rather than on the arithmetic it feeds into.
A second failure is holding through the announcement with a stop. The move gaps past the level, so the protection that was planned is not the protection that is received.
A third is ignoring the financing cost on a long-held leveraged position, which quietly converts a small edge into no edge.
A fourth is treating the headline rate as the only rate, when the curve has many and they disagree.
And a fifth is confusing the nominal rate with the real one. A rate of 5% while prices rise 3% is not 5% of purchasing power — it is about 2%, and inflation is the other half of that sum.
Related
Leverage covers borrowed positions, which is where the rate is charged directly. Inflation covers what the money will buy when it arrives. And risk management covers sizing a position whose carrying cost runs every night.
The reason a rate change moves everything at once is not sentiment. It is arithmetic: every asset is a claim on money arriving later, and the rate is the number that converts later into now. Change that number and every one of those claims is worth something different, whether or not anything about the asset changed.
— Michael Whitman
This page is educational, not financial advice. Test every idea on your own charts before risking money.