Effective annual interest rate

Also found in: Acronyms.

Effective annual interest rate

An annual measure of the time value of money that fully reflects the effects of compounding.
Copyright © 2012, Campbell R. Harvey. All Rights Reserved.

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.
Farlex Financial Dictionary. © 2012 Farlex, Inc. All Rights Reserved
References in periodicals archive ?
The effective annual interest rate on an RAL can be quite high, given that the RAL fee is in effect an interest charge for the two- or three-week period that it would otherwise take to receive the refund.
Although the interest rate is variable, the company elected to fix the base LIBOR interest rate at 2.32% per annum for seven years by signing an interest rate swap and under this and based on its total leverage ratio on 26 August 2013, the effective annual interest rate on the term loan is 3.97%.
The effective annual interest rates for such advances can sometimes exceed 100 percent, thus eating away a substantial part of the pension's present value.