NOMINAL AND EFFECTIVE RATE OF INTEREST:

DEFINITION:
 When interest is compounded more than once per year , the
given annual rate is called the nominal annual rate or
Nominal rate.
Formula : i(m) = m[(1+i)(1/ m)-1]

 The rate of interest actually earned in one year is called the

effective annual rate or the effective rate.

Formula : i = (1+i(m) /m)m-1

Problem1:
Find the effective rate p.a. corresponding to the nominal
rate of 8% p.a. convertible quarterly.
Solution:
i(m) = 8% = 0.08, m=4
Effective rate i = (1+i(m) /m)m-1
=(1+0.08 (4) /4)4-1
=(1.02)4-1
=1.08243-1
 =0.08243.
Thus the given nominal rate corresponds to an effective rate of
8.243% p.a.

Problem2:
Find the nominal rate p.a. convertible quarterly
corresponding to an effective rate of 8% p.a.
Solution:
i = 8% = 0.08, m=4
Nominal rate i(m) = m[(1+i)(1/ m)-1]
= 4[(1+0.08)(1/ 4)-1]
= 4[1.019427-1]
=?
Problem 3:H/W
Find four decimal places the nominal rate p.a. convertible
quarterly corresponding to an effective rate of 6% p.a.
Problem 4 :
Find the effective rate p.a. corresponding to the nominal
rate of 12% p.a. convertible monthly.
Solution:
i(m) = 12% = 0.12, m=12
Effective rate i = (1+i(m) /m)m-1
Ans:?
Problem 5 :
Find the amount of Rs.1000 at the end of 10 years,
i)at nominal rate of interest of 12% p.a. quarterly
ii) at effective rate of interest 3% per half year.
Solution:
i(m) = 12% = 0.12, m=4
i =?
n=10
A = C(1+i)n
=1000(1+ )10 (substitute i value)

=?
i =3% =0.03

n = 10 x2

n= 20

A = C(1+i)n
=1000(1+0.03)20
 =?
Problem 6 :
Find the present value of Rs.1000 due 10 years hence,
i)at nominal rate of interest of 6% p.a. convertible
monthly
ii) rate of interest of 1% per quarter.
Solution:
i) i(m) = 6% = 0.06, m=12,
i=?
P.V = sum x vn
=1000 x 1/ (1+ )10 (substitute i value)

=?

ii)i=1%=0.01,m=4,n=4 x 10=40

P.V = sum x vn
=?