CSE24_11000123035___Economics>Engg.,.pdf

Economics for Engineerimg

1. TOPIC : Nominal Interest and Effective Interest
Name: SayanDas
College : Government College of Engineering and Textile Technology, Serampore
Subject : Economics for Engineering (Humanities-II)
Subject Code : HSMC 301
Stream : Computer Science and Engineering
Semester : 3rd
University Roll No : 11000123035

2. Nominal vs.
Effective Interest
Rates
This presentation will explore the difference between nominal and
effective interest rates. We will discuss how these rates are calculated
and how they are used in financial decision-making.

3. Understanding Nominal
Interest Rate
The nominal interest rate is the stated interest rate on a loan or investment. It
represents the annual percentage return you will earn on your investment or
the cost of borrowing money.
Simple Interest
This is a fixed percentage of the
principal amount.
Compound Interest
The interest earned on the
principal is added to the
principal and then earns
interest.
Annual Percentage Rate (APR)
The nominal interest rate can be expressed as APR which represents the
annual cost of borrowing money.

4. Calculating Nominal
Interest
The nominal interest rate is calculated by multiplying the principal
amount by the interest rate and the time period.
Formula: Nominal Interest = Principal
x Interest Rate x Time

5. Understanding Effective
Interest Rate
The effective interest rate reflects the true cost of borrowing or the actual
return on an investment after accounting for compounding.
1
Compounded
Interest
When interest is earned
not only on the principal
but also on the
accumulated interest.
2
Frequency of
Compounding
The more frequently
interest is compounded,
the higher the effective
interest rate.
3
Annual Percentage Yield (APY)
The effective interest rate can be expressed as APY which
represents the actual return on an investment.

6. Calculating Effective
Interest
The effective interest rate is calculated using a formula that takes into
account the nominal interest rate and the compounding frequency.
Formula: Effective Interest Rate = (1 +
(Nominal Interest
Rate/Number of
Compounding
Periods))^Number of
Compounding Periods -1

7. Factors Affecting Effective Interest
There are several factors that can affect the effective interest rate including the nominal interest rate, the compounding frequency, and the
length of the investment or loan period.
Inflation
As inflation rises, the purchasing power
of money decreases, leading to higher
effective interest rates.
Risk Premium
Higher risk investments typically have
higher effective interest rates to
compensate for the risk.
Market Conditions
Changes in the market can affect interest
rates and, subsequently, effective
interest rates.

8. Comparing Nominal and Effective Interest
The nominal interest rate is the stated interest rate, while the effective interest rate reflects the true cost of borrowing or
the actual return on an investment.
Nominal Interest
Does not account for compounding.
Provides a simple overview of the interest rate.
Can be misleading if compounding occurs frequently.
Effective Interest
Reflects the actual cost of borrowing or the return on an
investment.
Accounts for compounding frequency and provides a
more accurate picture.
Helps in making informed financial decisions.

9. Conclusion and Key Takeaways
It's crucial to understand the difference between nominal and effective interest rates.
Compounding
Effective interest rates are influenced by compounding. The more frequently interest is compounded, the
higher the effective interest rate.
Risk
Higher-risk investments usually have higher effective interest rates to compensate for the risk involved.
Financial Decisions
Understanding effective interest rates is vital for making informed financial decisions. It helps compare
different investment options or loan offers.

10. References
❖"Financial Markets and Institutions" by Frederic S. Mishkin and Stanley Eakins
❖Investopedia. (2023). Nominal Interest Rate. Retrieved from https://www.investopedia.com/terms/n/nominalinterestrate.asp
❖"Fundamentals of Corporate Finance" by Stephen A. Ross, Randolph W. Westerfield, and Bradford D. Jordan
❖"Nominal vs. Effective Interest Rates" by ZviBodie, Alex Kane, and Alan J. Marcus(Journal of Finance)

11. THANK YOU