Financial Math-Different Type Of Interest Rate

July 22nd, 2007 Comments off
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Types Of Interest Rates

There are a few types of Interest Rate which are as follows:

Nominal Rate

Nominal means “in name only”. This is sometimes called the quoted rate

Periodic Rate

The amount of interest you are charged each period, like every month.

Effective Annual Rate

The rate that you actually get charged on an annual basis. Remember you are paying interest on interest.

Formulas:

Nominal Rate

Perodic Rate X Number of Compounding Periods

Effective Annual Rate

= (1+ i / m)m -1

  • m = the number of compounding periods
  • i = the nominal interest rate

Mr A has a Credit Card with an interest rate on the card as 3% per month.

Question:

Explain the various types of interest rates?

Solution:

Nominal Rate =

3% per month x 12

36%

Periodic Rate =

The amount of interest Mr A is each month.

3%

Effective Annual Rate

The rate that Mr A actually get charged on an annual basis. (note that Mr A is e paying interest on interest.)

Effective Annual Rate

= (1+ i / m)m – 1

= ( 1 + .36 / 12 )12 -1

= (1.03)12 – 1

= (1.4257) -1

= 0.4257

[ m = the number of compounding periods ]

[ i = the nominal interest rate ]

 

 

 

 

 

 

 

 

 

42.57 %

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