Interest rates are the nerve center of the financial markets.
We all talk about interest rates, whether we are talking about the interest on our bank account or the rate we pay on our home mortgage. It is an indicator that concerns all individuals, but as far as the financial markets are concerned, it the interest rate market is at the intersection of all asset classes, from foreign exchange to commodities.
An interest rate is, as we all know, a number expressed as a percentage, which is paid by a person, a bank, a state or a company that has borrowed money, to the organization that has lent it.
This rate, called the nominal interest rate, compensates the lender for the twofold risk involved in this operation: On the one hand, the credit risk of not being repaid by the borrower; on the other, the risk that the money lent will lose purchasing power over time as a result of inflation.
The real interest rate is the nominal rate adjusted for the inflation rate over a given period. It allows us to know the real cost of a loan for the person who takes out the loan. For several years, thanks to the aggressive policies of central banks, real interest rates in the euro zone have been strongly negative.
We usually separate the interest rate markets into two: the money market and the bond market.
The money market is a sub-section of the interest rate market and specializes in short-term debt securities. The maturities in this sector will always be less than 12 months and are mainly concentrated in the period of 1 day to 3 months. Money market instruments usually take the form of treasury bills, which are issued by governments, or certificates of deposit, which are issued by banks.
Because they are mostly issued by governments or large financial institutions, money market instruments are very liquid and considered extremely safe. Their main characteristic is that they are usually traded in extremely large amounts.
The bond market is the sector of the financial market where medium and long-term debt securities are traded. It is a lending/borrowing market and the instruments are either bonds or medium term notes (MTNs). Bonds can be issued by governments as well as companies (corporate bonds).