Chapter04

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Unformatted text preview: ual rate of interest actually paid or earned. Both businesses and investors need to make objective comparisons of loan costs or investment returns over different compounding periods. In order to put interest rates on a common basis, to allow comparison, we distinguish between nominal and effective annual rates. The nominal, or stated, annual rate is the contractual annual rate of interest charged by a lender or promised by a borrower. The effective, or true, annual rate (EAR) is the annual rate of interest actually paid or earned. The effective annual rate reflects the impact of compounding frequency, whereas the nominal annual rate does not. Using the notation introduced earlier, we can calculate the effective annual rate, EAR, by substituting values for the nominal annual rate, i, and the compounding frequency, m, into Equation 4.21: EAR 1 im m 1 (4.21) We can apply this equation using data from preceding examples. EXAMPLE Fred Moreno wishes to find the effective annual rate associated with an 8% nom...
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This document was uploaded on 03/03/2014 for the course MBA BMMF at Open University Malaysia.

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