An interest rate is either the cost of borrowing money or the reward for saving it. It is calculated as a percentage of the amount borrowed or saved.
It is how much someone would pay or receive for lending or borrowing capital from someone else. And it is an important tool for the Central Banks.
They usually manipulate the interest rates according to how they expect the economy to react. If capital is expensive to lend, more investors are incentivize to hold their money accruing interest, while borrowers are encourage to not get more debt, which helps deaccelerate the economy.
The opposite is true: by lowering interest rates, the Central Banks want to see strong economic activity, as staying still is more expensive than the opportunity cost of leveraging to start new businesses.
Why Interest Rates Affect the Stock Market?
Last week, a known phenomenom in the Capital Markets caused it to Stock Market to crash: the ten year bonds yield rose.
It happened because inflation expectation. If investors believe inflation will be significantly higher than the interest rate the US treasury bond pays at its maturity, they don't buy the debt.
It is sensical: no one would want to hold something that would yield less than the value they have bought it for. If no one buys, the amount of sellers in the market outnumber the amount of willing buyers, and the price of the bond falls.
But if the price of bond falls, the yield rises. It happens because the yield a fixed term. The Government monetizes the debt and sets the interest it will pay for it upfront. Who holds the debt will always receive the same amount.
But if someone sells it for less than it has bought it for, it means that relatively to the selling price, the yield will be bigger for the buyer. And if the yield collected is big enough, big institutions that were pushed to risky assets, such the Stock Market, reconsider buying that debt.
To buy that debt, they have to sell their risky positions, which means a sell-off also happens in the Stock Market. Given it is a very emotional place, many retail investors (or even other institutions) leaverage the whales exit to sell to, either to wait until the market calms down or simply panic-selling.
I like to see the Capital Markets as an interconnected system: depending on how something happens at one point, and at what rate, it determines how the other end of the equation will respond. It is fascinating.