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Lecture_sept_28_TVM

# Lecture_sept_28_TVM - ORIE 350 Time Value of Money(cont...

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ORIE 350 September 28, 2006 Time Value of Money (cont.)

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Nominal and Effective Interest Rates Nominal interest rates are stated in terms of annual rates. When interest is compounded for less than a year, the following steps are necessary before compound interest amounts can be calculated. Nominal rates are used in business, because they are so easy to deal with. In this class, when given an interest rate, assume it is a nominal annual rate unless specified otherwise.
Nominal Rate Procedure 1. Divide the nominal interest rate by the number of compounding periods per year to determine the interest rate per compounding period. 2. Multiply the number of years involved by the number of compounding periods per year to obtain the total number of interest compounding periods.

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Example Nominal interest rate: 10% Interest compounded: monthly for 15 years Interest rate per compounding period: 0.10 ÷ 12 = 0.0083333 No. of compounding periods: 15 years x 12 compoundings per year = 180 periods.
APR Many advertisements for automobile loans, home mortgages, and other financed consumer items, as well as financial investment products, include the effective annual percentage rate or “APR.” The APR is merely the interest rate that would result in the same amount of interest paid per year if the interest were compounded annually (instead of monthly, quarterly, etc.).

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APR The APR is of limited value, but we must live with it, apparently. APR’s are not useful in calculations, we must convert to nominal rates first.
The APR Equation APR = effective annual interest rate or APR i nom = nominal annual interest rate c = no. of compounding periods per year c nom i APR= 1+ -1 c

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Example For Example 1 above, we can find the APR.
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Lecture_sept_28_TVM - ORIE 350 Time Value of Money(cont...

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