Question

An investor can invest money with a particular bank and earn a stated interest rate of 13.20%; however, interest will be compounded quarterly. What are the nominal, periodic, and effective interest rates for this investment opportunity

Answer 1

The effective compound interest rate is 13.87%.

What is Compound Interest?

• The interest on a loan or deposit that is calculated based on both the initial principle and the accumulated interest from prior periods is known as compound interest (also known as compounding interest).
• Compound interest, sometimes known as "interest on interest," is said to have its roots in 17th-century Italy. Compared to simple interest, which is calculated solely on the principal amount, it will cause a sum to grow more quickly.
• The frequency of compounding determines the rate at which compound interest accumulates.
• The compound interest increases with the number of compounding periods.
• For instance, during the same period of time, the amount of compound interest accrued on $100 compounded at 10% yearly will be less than $100 compounded at 5% semi-annually.

Nominal = interest rate

That is Nominal rate is also known as interest rate.

Nominal rate =  13.20%

The invested money is compounded quarterly.

Periodic = 13.2%/4 (quarterly)

Periodic rate = 3.30%

Now,

The interest rate that accounts for compounding over a specific time period is called the Effective Annual Interest Rate (EAR). The rate of interest that an investor can earn (or pay) in a year after taking into account compounding is known as the effective annual interest rate, to put it simply.

Effective annual rate = EFF% = [1 + (0.13200 / 4)]⁴ - 1 = 13.87%

Know more about Compound Interest with the help of the given link:

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