MATH 2FM3 Lecture Notes - Lecture 3: Compound Interest, Nominal Interest Rate, Effective Interest Rate

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Assume you make no payments for one year. How much do you owe at the end of the year: solution: the nominal interest rate is rn = 24%; compounding period=1 month; whence rn = 1. 12 24% = 2% is the monthly interest rate. The balance 1000 compounded monthly at 2% yields 1000(1. 02)12 = 1268. 23 after 12 months. Hence re = 26. 82% is the e ective annual rate of interest: de nition: a nominal annual rate of interest compounded m times per year refers to an compounding period of 1. Interest rate for 1 m years. m period = quoted nominal annual interest rate m. 0: example: bank a o ers an annual rate of 15. 25% with interest compounded semiannually and bank b o er an annual rate of 15% with interest compounded monthly. Which bank gives a better deal: solution: bank a 6-months interest rate= 15. 25%

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