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37.-Equivalent-Rates GENMATH

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130 views5 pages

37.-Equivalent-Rates GENMATH

Uploaded by

zeianneh
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd

Equivalent rates

Two annual rates with different conversion periods that will earn
the same maturity value for the same time/term.

Nominal rate
Annual interest rate (may be compounded more than once a year)

Effective rate
This is the simple interest rate that would produce the same
accumulated amount in 1 year as the nominal rate compounded m
times a year. 𝒏
𝒓𝒏
𝒓𝒆𝒇𝒇 = 𝟏+ −𝟏
𝒏
Example 1.
What effective rate is equivalent to 10% compounded quarterly?

Solution.

Since the equivalent rates yield the same maturity value, then
𝑛 𝑛
𝑟
𝑟1 = 1 + −1
𝑛

0.10
4 𝑟 1 = 0.103813 or 10.3813%
1
𝑟 = 1+ −1
4
12.6825%

7.9216%

12.304%
Example 2.
What nominal rate compounded monthly is equivalent to 12%
compounded annually?
𝟏
𝒓𝒏 = 𝒏 𝟏 + 𝒓𝟏 𝒏 −𝟏
Given: 𝟏
𝑛 = 12 𝑟1 = 12% 𝒓𝒏 = 𝒏 𝟏 + 𝒓𝟏 𝒏 −𝟏
1
𝑟12 = 12 1 + 0.12 12 −1
𝒓𝟏𝟐 = 𝟏𝟏. 𝟑𝟖𝟔𝟓𝟓%
Example 3.
What simple interest rate is equivalent to 10% compounded semi-
annually at the end of year 1?
𝒏 𝒎
𝒓
𝒓𝒔 = 𝟏 + −𝟏
𝒎
Given:
𝑚=2 𝑟 2 = 10%
2
0.10 𝒓𝒔 = 𝟎. 𝟏𝟎𝟐𝟓 or 𝟏𝟎. 𝟐𝟓%
𝒓𝒔 = 1 + −1
2

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