Question

he number of compounding periods in one year is called compounding frequency. The compounding frequency affects both the present and future values of cash flows. An investor can invest money with a particular bank and earn a stated interest rate of 15.40%; however, interest will be compounded quarterly. What are the nominal, periodic, and effective interest rates for this investment opportunity

Answer 1

Answer:

1. 15.40%

2. 3.85%

3. 16.31%

Explanation:

1. Nominal rate = Interest rate

Nominal rate = 15.40%

The Nominal rate of the investment is 15.40%

2. Periodic rate = Nominal rate / Number of time compounded in year

Periodic rate = 15.40 / 4

Periodic rate = 3.85%

The Periodic rate of the investment is 3.85%

3. Effective interest rate = (1 + Nominal Rate)^n  - 1

Effective interest rate = (1 + 015.40%/4)4 - 1

Effective interest rate = (1 + 0.1540/4)^4 - 1

Effective interest rate = (1 + 0.0385)^4 - 1

Effective interest rate = 1.0385^4 - 1

Effective interest rate = 1.16312396 - 1

Effective interest rate = 0.16312396

Effective interest rate = 16.31%

The Effective Annual Rate of the investment is 16.31%