Interest is the cost of using money. The interest rate paid is usually expressed in annual terms though money market instruments may have a shorter term than one year. An interest rate is determined¹ by dividing the amount of interest paid by the principal amount borrowed. For example, if a $1000 bond pays $85 in interest for one year, the annual interest rate is 8.5 percent. In the U.S. some interest-bearing bonds, such as municipals, entitle the bearer to an exemption² from certain taxes on interest income. The interest paid by a company on its outstanding debt as well as the interest paid by a homeowner on his/her mortgage, is deductible from income as an expense and so can reduce the amount of tax owed.

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