Ch4 Lecture Notes

Ch4 Lecture Notes - Nominal and Effective Interest Rates 1...

Info iconThis preview shows pages 1–14. Sign up to view the full content.

View Full Document Right Arrow Icon
1 Nominal and Effective Interest Rates
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
2
Background image of page 2
3 Nominal Interest Rate q A nominal interest rate , r, is an interest rate that does not include any consideration of compounding q Mathematically we have the following definition: r = (interest rate per period)(No. of Periods)
Background image of page 3

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
4 APR and APY q The terms APR and APY are used in many financial situations instead of nominal and effective interest rates. q The Annual Percentage Rate (APR) is the same as the nominal interest rate, and Annual Percentage Yield (APY) is used instead of effective interest rate.
Background image of page 4
5
Background image of page 5

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
6 Example: Wachovia
Background image of page 6
7 Examples – Nominal Interest Rates q 1.5% per month for 24 months q Same as: (1.5%)(24) = 36% per 24 months q 1.5% per month for 12 months q Same as (1.5%)(12 months) = 18% / year q 1% per week for 1 year q Same as: (1%)(52 weeks) = 52% per year
Background image of page 7

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
8 There are always 3 time based units associated with an interest rate statement. q Time period - the period over which the interest is expressed. This is the t in the statement of r % per time period t, for example, 1% per month. The time unit of 1 year is by far the most common. It is assumed when not stated otherwise. q Compounding period (CP) - the shortest time unit over which interest is charged or earned. This is defined by the compounding term in the interest rate statement, for example, 8% per year compounded monthly. If not stated, it is assumed to be 1 year. q Compounding frequency - the number of times that m compounding occurs within the time period t. If the compounding period CP and the time period t are the same, the compounding frequency is 1, for example, 1%
Background image of page 8
9
Background image of page 9

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
10 10 4.5% per 6 months – compounded weekly q Nominal Rate: 4.5%. q Time Period: 6 months. q Compounded weekly: q Assume 52 weeks per year q 6-months then equal 52/2 = 26 weeks per 6 months q The effective weekly rate is: q (0.045/26) = 0.00173 = 0.173% per week
Background image of page 10
11 11 q The derivation of an effective interest rate formula directly parallels the logic used to develop the future worth relation: q The future worth F at the end of 1 year is the principal P plus the interest P ( i ) through the year. q Since interest may be compounded several times during the year, replace i with the effective annual rate i a and write the relation for F at the end of 1 year.
Background image of page 11

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
12 12 The rate  per CP must be compounded through all  periods to obtain the total  effect of compounding by the end of the year.
Background image of page 12
13 13 Symbols used for nominal and effective interest rates
Background image of page 13

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Image of page 14
This is the end of the preview. Sign up to access the rest of the document.

This note was uploaded on 04/07/2008 for the course MSE 304 taught by Professor Reiner during the Spring '08 term at CSU Northridge.

Page1 / 40

Ch4 Lecture Notes - Nominal and Effective Interest Rates 1...

This preview shows document pages 1 - 14. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online