BUSINESS ADMINISTRATION
BUSINESS MATHEMATICS
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Question
[CLICK ON ANY CHOICE TO KNOW THE RIGHT ANSWER]
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Equivalent rates
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Nominal rates
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Effective rates
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Common rates
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Detailed explanation-1: -The nominal rate is the interest rate as stated, usually compounded more than once per year. The effective rate (or effective annual rate) is a rate that, compounded annually, gives the same interest as the nominal rate. If two interest rates have the same effective rate, we say they are equivalent.
Detailed explanation-2: -The effective annual rate is normally higher than the nominal rate because the nominal rate quotes a yearly percentage rate regardless of compounding. Increasing the number of compounding periods increases the effective annual rate as compared to the nominal rate.
Detailed explanation-3: -The stated annual rate describes an annualized rate of interest that does not take into account the effect of intra-year compounding. Effective annual rates do account for intra-year compounding of interest. Banks will often show whichever rate appears more favorable, according to the financial product they’re selling.
Detailed explanation-4: -Effective annual interest rate = (1 + (nominal rate ÷ number of compounding periods)) * (number of compounding periods)-1.