Weighted Average Interest Rate
The Weighted Average Interest Rate measures the overall interest rate in a loan market or portfolio, accounting for loans with different interest rates and sizes. It ensures larger loans have a proportional impact, offering an accurate view of borrowing costs.
Weighed Average Interest Rate is used when showing the overrall interest of the loans in the Moria Protocol.
Formula
The formula is:
\[ \text{Weighted Average Interest Rate} = \frac{\sum (\text{Loan Size}_i \times \text{Interest Rate}_i)}{\sum \text{Loan Size}_i} \]
Where:
- \(\text{Loan Size}_i\): Principal amount of loan and owed interest \(i\).
- \(\text{Interest Rate}_i\): Interest rate of loan \(i\).
- \(\sum\): Summation over all loans.
Why It Matters
- Accurate Weighting: Larger loans influence the rate more, reflecting their market significance.
- Versatile Use: Used by financial institutions and analysts to assess borrowing costs or compare market trends.
Example
For a portfolio with:
- Loan 1: $100,000 at 5%
- Loan 2: $200,000 at 4%
- Loan 3: $50,000 at 6%
\[ \frac{(100,000 \times 0.05) + (200,000 \times 0.04) + (50,000 \times 0.06)}{100,000 + 200,000 + 50,000} = \frac{5,000 + 8,000 + 3,000}{350,000} = \frac{16,000}{350,000} \approx 0.0457 \text{ or } 4.57\% \]
The result, 4.57%, represents the effective interest rate.
Other Applications
- Loan Portfolios: Evaluate average borrowing costs.
- Market Analysis: Compare interest rates across markets or periods.
- Reporting: Provide a clear metric for stakeholders.