SAINT FRANCIS COLLEGE

Bateria, Guihulngan City, Negros Oriental

Tel. No. 336-1099 or 231-3120

SUBJECT: GENERAL MATHEMATICS B1

SEMESTER: FIRST
INSTRUCTOR: ANGELA L. GENERALAO
MODULE: 9

Effective Rate of Interest

r
The effective rate of interest, denoted by e is the simple interest rate that will produce the sae
future value as nominal interest rate of r compounded m times a year in one year.
The effective rate of interest is also called yield rate, effective annual yield, or annual
percentage yield.

Theorem 3.3.1
a. Effective rate of interest
r e equivalent to the nominal annual interest rate r compounded

m times a year is given by

( )
r e = 1+
r m
m
−1

b. The effective rate of interest

r e equivalent to the nominal annual interest rate r
r
compound m times a year continuously is given by r e =e −1
Example 1
Find the effective rate of interest equivalent to the following rates:
a. 2% annual compound interest rate
b. 2.75% interest rate compounded semiannually
c. 4% interest rate compounded monthly
d. 2.5% interest rate compounded continuously
Solution:
Use theorem 3.3.1

a.
( )
r e = 1+
r m
m
−1=(1 . 02)−1=0 .02=2 %

b.
( ) (
r e = 1+
r m
m
−1= 1+
2)
0 . 0275 2
−1≈0 .0277 or 2 .77 %

r =(1+ ) −1=( 1+
12 )
m 12
r 0 . 04
e −1≈0 . 0407 or 4 . 07 %
c. m
r 0 . 025
d. r e =e −1=e −1≈0 . 0253 or 2 .53 %

Example 2
At what effective rate of interest must you invest ₱25,000 in order to double its value in 10
years?

1
Solution:

A=P(1+r )t
₱50,000=₱25,000(1+r )10

2=(1+r )10

1+r =10√ 2

r =10√ 2−1≈0 . 0718

Hence, the required effective rate of interest is approximately 7.18%.

Example 3
Which of the following rates will give the highest future value for a certain principal after 10
years?
a. 9.6% annual compound interest rate
b. 9.5% nominal interest rate compounded quarterly
c. 9.4% nominal interest rate compounded monthly
d. 9.3% nominal interest rate compounded continuously
Solution:

a.
r e =9 . 6 %

b.
(
r e = 1+
0. 095 4
4 )−1≈0 . 0984 or 9 .84 %

c.
(
r e = 1+
12 )
0 . 094 12
−1≈0 . 0982 or 9. 82 %
0. 093
d. r e =e −1≈0. 0975 or 9 .75 %

Since the situation in b has the highest equivalent effective rate of interest, then it will produce
the highest future value.

Supplemental Exercise: Read the problem carefully and write your answer with solution in a
yellow pad paper.

1. Find the effective rate of interest equivalent to the following rate:

a. 3% annual compound interest rate
b. 2.8% interest rate compounded quarterly
c. 2.5% interest rate compounded monthly
d. 2% interest rate compounded continuously

2. In order to earn an interest of ₱5,000 from an initial deposit of ₱50,000, at what effective
rate of interest must the deposit have?