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.

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.
References in periodicals archive ?
For example, a "5-6 loan" that lends P1,000 with repayment of P40 per day for 30 days actually has a whopping effective annual interest rate of 439 percent