effective interest rate

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Effective Interest Rate

The annual rate at which an investment grows in value when interest is credited more often than once a year.

Effective Interest Rate

The interest rate on a debt or debt security that takes into account the effects of compounding. For example, if one has a fixed-income investment such as certificate of deposit that pays 3% in interest each month, the effective interest rate is more than 3% because compounding the interest results in a (slightly) greater principal each month on which the interest rate is calculated. In this example, the effective interest rate is calculated thus:

Effective interest rate = (1 + .03/12)^12 - 1 = .0304 = 3.04%, where .03 is the simple interest rate and 12 is the number of times in a year interest is compounded. It is also known as the annual effective rate or the annual equivalent rate. See also: Stated annual interest rate, annual percentage yield.

effective interest rate

the INTEREST RATE payable on the purchase price of a BOND. For example, a bond with a face value of £100 and a NOMINAL (COUPON) INTEREST RATE of 5% generates a nominal return of £5 per year. If, however, the bond can be purchased for £50 on the open market, then the effective interest rate now rises to 10%, representing a 10% return on the £50 invested. The lower the purchase price of a bond with a given nominal rate of interest, the higher its effective rate of interest will be, and vice-versa. There is thus an inverse relationship between the price paid for a bond and its effective rate of interest (sometimes called the interest YIELD).

effective interest rate

The actual interest rate of a loan,regardless of the face interest rate or the rate quoted.See annual percentage rate.

References in periodicals archive ?
Annual Equivalent Rate - what the interest rate would be if interest was paid and compounded each year.
This is sometimes described as the AER or annual equivalent rate.
HOW MANY OF THE FOLLOWING INTEREST-RELATED ABBREVIATIONS CAN YOU EXPLAIN: APR, AER, SVR (ANNUAL PERCENTAGE RATE, ANNUAL EQUIVALENT RATE AND STANDARD VARIABLE RATE)?
FINANCIAL DICTIONARY: AER THE AER or annual equivalent rate is the total interest you will receive on your savings in one year.
When told it meant annual equivalent rate,the amount of interest an account will earn over a year, more than half couldn't work out how muchpounds 100 would earn in a year, if it was in an account earning three per cent AER.
Just 4pc of people knew that AER or annual equivalent rate referred to the interest paid on savings, though 38pc knew that APR or annual percentage rate was linked to interest on borrowings - which National Savings said reflected the dominance of borrowing money in today's culture.
The Annual Equivalent Rate, or AER, is the rate of interest calculated on your savings account.

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