NOMINAL INTEREST RATE

In finance and economics, nominal interest rate

refers to the interest rate without the adjustment of
inflation. It is basically the rate “as stated”, “as
advertised” and so on which does not take inflation,
compounding effect of interest, tax or any fees in
the account.
It is also known as Annualized Percent Rate. This is
the interest compounded or calculated once in a
year.
FORMULA:
Nominal interest rate formula = [(1 + Real interest
rate) * (1 + Inflation rate)] – 1

• Real Interest Rate is the interest rate that takes

inflation, compounding effect and other charges
into account.
• Inflation is the most important factor that
impacts the nominal interest rate. It increases
with inflation and decreases with deflation.
Let us assume that the real interest rate of
investment is 3% and the inflation rate is
2%. Calculate the Nominal Interest Rate.
Therefore, it can be calculated using the formula as
below:
Nominal interest rate formula = [(1 + Real interest
rate) * (1 + Inflation rate)] – 1

NIR = [(1 + 3%) * (1 + 2%)] – 1

Nominal rate = 5.06%
• It is widely used in banks to describe interest on
various loans.
• It is widely used in the investment field to suggest
investors for various investment avenues present in the
market.
• For example, Car loan available at 10% of interest rate.
This face an interest rate of 10% is the nominal rate. It
does not take fees or other charges in an account.
• Bond available at 8% is a coupon rate as it does not
consider current inflation. This face interest of 8% is
the nominal rate.
CONCLUSION:
Nominal interest is a stated interest rate, therefore,
is a catchy term and it can deceive borrower or investor
as it does not give the true picture of the cost of
borrowing or net return from an investment.
As it does not consider inflation, tax, investment
fees, compounding effect of interest, we must use
alternate interest rate like real interest rate or effective
interest rate for actual assessment of our cost of
borrowing or investment as and where suited.