ةيئابرهكلا ةسدنهلا مسق – ةسدنهلا
ةيلك
يناثال يساردال لصفال – م: 2020/ 2021يساردال
ةعبارلا :ةقر
ماعال يسدنهلا داصتقالا :ررقمال فلا
ةرضاحمال4: NOMINAL AND EFFECTIVE INTEREST
مقر رضاحملا:
Mr. MUBARAK MOHAMMED
ناونع
SYLLABUS
Fundamentals of Engineering Economy
How Time & Interest Affect Money
Nominal and Effective Interest Rate
Present, Annual, and Rate of Return Analysis
Breakeven, Sensitivity, and Payback Analysis
Replacement and Retention Analysis
Cost Estimation Approaches
Depreciation.
2
OBJECTIVES
Identify the nominal and effective interest
Perform the nominal and effective interest
Convert nominal interest into effective interest.
Nominal and Effective Interest
Effective Interest: the interest which is calculated once in interest
period (month , semi-annual , annual).
Nominal Interest: the interest which calculated more than once in interest
period.(compounded monthly, compounded quarterly, compounded semi-
annually, etc.)
Nominal and Effective Interest
All interests must be expressed as effective interest before using the
calculation expression.
A nominal interest rate (r) is the interest rate per period times the
number of periods.
In equation form:
Nominal and Effective Interest
The nominal interest can be converted into an effective interest using:
Where:
i is the effective interest rate for a certain period.
r is the nominal interest rate for that period of effective interest.
m is the number of times interest is compounded in that same period.
Effective interest rates can be calculated for any time period longer
than the compounding period of a given interest rate.
Nominal and Effective Interest
• If we allow compounding to occur more and more frequently, the
compounding period becomes shorter and shorter. Then m, the
number of compounding periods per payment period, increases. This
situation occurs in businesses that have a very large number of cash
flows every day, so it is correct to consider interest as compounded
continuously.
• As m approaches infinity, the effective interest rate in above equation
reduces to:
Nominal and Effective Interest
Example:
a. A Visa credit card issued through Chase Bank carries an interest rate
of 1% per month on the unpaid balance. Calculate the effective rate
per semiannual period.
b. If the card’s interest rate is stated as 3.5% per quarter, find the
effective semiannual and annual rates.
Solution:
a. The compounding period is monthly. Since the effective interest
rate per semiannual period is desired, the r must be the nominal rate
per 6 months.
Nominal and Effective Interest
The m is equal to 6, since interest is compounded 6 times in 6 months.
The effective semiannual rate is:
b. For an interest rate of 3.5% per quarter, the compounding period is
quarterly. In a semiannual period, m = 2, r = 7%.
Nominal and Effective Interest
The effective interest rate per year is determined using r = 14% and m = 4.
Note that the term rm in Equation above is always the effective interest rate
per compounding period.
Nominal and Effective Interest
Example:
a. For an interest rate of 18% per year compounded continuously,
calculate the effective monthly and annual interest rates.
b. An investor requires an effective return of at least 15%. What is the
minimum annual nominal rate that is acceptable for continuous
compounding?
Solution:
a. The nominal monthly rate is r = 18% / 12 = 1.5 % , the effective
monthly rate is:
Nominal and Effective Interest
b. For continuous compounding:
1
4
1
5
