Effective and Nominal Interest Rates

Relationship between effective and nominal interest rates

Interest rate is only meaningful in the context of time - in general is understood as - per year - which may be called

  • the nominal interest rate

With other periods of time than year - like month, week, or day - the interest rate may be called 

  • the effective interest rate 

Calculating Nominal Interest Rate

Nominal interest rate for a period with effective interest rates for it's subperiods can be calculated as

i = (1 + ie)n - 1            (1)

where

i = nominal interest rate for the period

ie = effective interest rate for the subperiod

n = number of subperiods

Example - Nominal interest rate with Effective monthly interest rates

Nominal interest rate (per year) with monthly effective rates of 1% can be calculated as

in = (1 + 0.010)12 - 1

    =  0.127

    = 12.7%

Calculating Effective Interest Rate

Effective interest rate for the subperiods of a period can be calculated as

ie = (in + 1)1/n - 1        (2)

Example - Nominal interest rate with Effective monthly interest rates

Effective interest rate per month with a nominal rate of 10% can be calculated as

ie = (0.1 + 1)1/12 - 1

    =  0.00797

    = 0.797%

Related Topics

  • Economics - Engineering economic concepts - cash flow diagrams, discount rate, internal rate of return - IRR, income taxes, inflation

Related Documents

Search the Engineering ToolBox

Engineering ToolBox - SketchUp Edition - Online 3D modeling!

3D Engineering ToolBox - draw and model technical applications

Engineering ToolBox - SketchUp Edition - add standard and customized parametric components - like flange beams, lumbers, piping and more - to your SketchUp model - enabled for use with the amazing, fun and free SketchUp Make and SketchUp Pro. Add from the Sketchup Extension Warehouse!

Translate the Engineering ToolBox!
About the Engineering ToolBox!