The number of compounding periods in one year is called compounding frequency. T

Question

The 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 6.60%; however, interest will be compounded quarterly. What are the nominal, periodic, and effective interest rates for this investment opportunity? Rahul needs a loan and is speaking to several lending agencies about the interest rates they would charge and the terms they offer. Me particularly likes his local bank because he is being offered a nominal rate of 6%. But the bank is compounding semiannually. What is the effective interest rate that Rahul would pay for the loan? 5.996% 6.175% 6.090% 6.404% t

Explanation / Answer

Question 1. Nominal rate = 6.60% (same as no inflation rate is given)

Periodic rate = 1.65% (formula = Interest rate / number of periods per year)

Effective rate = 6.765 [ Use formula r = (1 + i / n)n - 1]

Question 2. Effective Interest rate = 6.090%

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