# effective interest rate

(redirected from Effective Annual Rates)

## 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 ?
In addition to effective annual rates, there are also effective periodic rates (EPR).
The effective annual rate (EAR) is the rate that, under annual compounding, would have produced the same future value at the end of one year as was produced by more frequent compounding.
Example: What is the effective annual rate in a bank account that has an APR of 6%, but the interest is compounded quarterly?
Effective Annual Rate (EAR) = [(1 + APR/m).sup.m] - 1
Consider Erik and Erin who want to make an immediate lump sum deposit into an account earning an effective annual rate of 5% in order to fund four years of college expenses starting at the end of this year.
Example: Assume that Thomas will make annual payments (3) into a 401(k) for 20 years earning an effective annual rate of 9%.
And research of overdrafts shows that some providers are charging EARs (Effective Annual Rates) on authorised overdrafts as high as 20 per cent and for unauthorised overdrafts over 30 per cent.

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