EECO101

ENGINEERING ECONOMY
 Compound
Interest
Nominal and Effective
Rates
Three Kinds of Rates

1. Periodic rate (i) - it is the rate used to compute

compound interest factors, and it is equal to
interest rate divided by the conversion period.

2. Nominal rate (J) - the stated annual rate of

interest when the conversion period is other than
a year.

3. Effective rate ( e) - the annual rate of interest

when the conversion period is one year.
Nominal rate ( J)
- the rate quoted when interest is compounded
more than once a year.
- In any investment problem, if the rate is not
specified as nominal or effective, it is assumed the
given rate is nominal.
1
𝐽 =𝑚 1+𝑒 𝑚 − 1 × 100%
where:
J - nominal rate
m - conversion period per year
e - effective rate
What nominal rate compounded monthly,
will yield an effective rate of 5.5%?

𝐹=𝐹
12 1
𝑟 0.05
𝑃 1+ =𝑃 1+
12 1
𝑟 12
1+ = 1 + 0.05
12

𝑟 = 0.0489 = 4.89%
When interest is compounded quarterly,
find the nominal rate if the effective rate
is:
a. 6.5%
b. 5/12%
c. 1 ¾%

𝑎. 𝑟 = 6.35%
𝑏. 𝑟 = 0.42%
c. 𝑟 = 1.74%
Effective rate ( e)
𝑚
𝐽
𝑒= 1+ − 1 × 100%
𝑚
where: e - effective rate
J - nominal rate
m - conversion period per year

 When interest is compounded annually, 𝑒 = 𝐽.

 When it is compounded more than once a year, 𝑒 > 𝐽.
 In comparing two different rates at different conversion
periods per year (m), their respective effective rates are
computed.
What effective rate can give you the same final

amount as when you place your money at 15%

compounded monthly?

12
0.15
1+ = 1+𝑒
12

𝑒 = 0.1608 = 16.08%
Berong has P100,000 to invest. Will he deposit the amount

in the bank paying 7.8% compounded semi-annually or

invest the money in an investment firm paying 7.7%

compounded monthly?

𝑟 = 7.8% 𝑚 = 2 𝑒 = 7.95%

𝑟 = 7.7% 𝑚 =12 𝑒 = 7.98%