Understanding Nominal vs Effective Interest Rates
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generoso SERVANIAUnderstanding Nominal vs Effective Interest Rates
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generoso SERVANIANOMINAL AND EFFECTIVE RATES
Nominal Interest Rate - Nominal means "in name only". This is sometimes called the quoted rate or
basic annual interest. It is the stated rate of interest applied to your investment.
Periodic Rate - The amount of interest you are charged each period, like every month.
Effective interest rate - the actual annual interest rate that occurs after taking into consideration the
effects of compounding (when compounding occurs more than once per year). The rate that you
actually get charged on an annual basis. Remember you are paying interest on interest.
Find the effective rate of interest of 8% compounded continuously.
2. Which of the following have the least effective annual rate of interest?
a. 12.30% compounded annually
b. 11.59% compounded semi-annually
c. 11.79% compounded quarterly
d. 11.68% compounded monthly
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