There is nothing new about a student who has just enrolled in a finance course asking how to calculate an effective interest rate. The effective interest rate implies the usage rate that a borrower needs to pay on loan. It can also be considered the market rate of interest or the yield to maturity. This rate may hugely vary from the rate stated on the loan document, based on an analysis of various factors with factoring calculator.
To aid you in today's comprehensive post, we will walk you through various steps you need to know to calculate effective interest rate faster and effectively in the long run. Let’s dive right in!
- Become Familiar With The Concept Of Effective Interest Rate
If the words of reputed Accounting Equation Assignment Help stalwarts are anything to go by, then the effective interest rate attempts to explain the full cost of borrowing. It considers the effect of compounding interest, which is left out of the nominal or 'stated' interest rate.
- Identify The Stated Interest Rate
The stated interest rate is usually the ‘headline’ interest rate. It’s the specific number that the lender typically advertises as the interest rate. This interest rate is normally expressed as a percentage.
- Identify The Number Of Compounding Periods
A look at accounting equation tutorials will reveal that the compounding periods will generally be quarterly, monthly, annually, or continuously. This refers to how often the interest is applied. Usually, the compound period is monthly. It is wise to still check with a lender to verify it.
- Know The Formula
Before you get started, it is essential to become well-versed with the formula for converting the stated interest rate to the effective interest rate (EIR). The EIR is usually calculated through a simple formula-
r= (1+i/n)^n-1.
- Calculate The EIR
Try to calculate the effective interest rate using the formula above. For instance, consider a loan with a stated interest rate of 5 percent compounded monthly. When you use the formula, it yields
r= (1+.05/12)^12-1 or r=5.12 percent
The same loan compounded daily will yield,
r= (1+.05/365)^365-1 or r=5.13 percent
If you still face difficulties, you can always fall back on the best college homework help stalwarts of the town.
- Know The Formula Used In Continuously Compound Interest
If interest is compounded constantly, it becomes essential to calculate the effective interest rate using a different formula, i.e.
r= e^i-1
In this formula, r is the effective interest rate, i is the stated interest rate, and e is the constant 2.718.
- Calculate The Effective Interest Rate
It is easy to calculate the effective interest rate in case of a continuously compounding interest if you are acquainted with the formula mentioned above. Like, try considering a loan with a nominal interest rate of 9 percent compounded continuously. The formula above will generate
r= 2.718 ^.09-1 or 9.417 percent
Hope we could help you with this information and contribute effectively towards developing a deep understanding of the subject. Go through this post, have the formulae at the back of your mind, and you'll be able to always calculate any effective interest rate problems like a pro.
Summary
Finding the accurate value of an effective interest rate is a mean feat to achieve. Hence, in this article, you will learn certain effective steps that will enable you to solve your papers remarkably. None of the steps are rocket science, but knowing them can effectively help you out in the long run.
Source URL: https://kansabook.com/read-blog/101397
Author Bio
Emily Jonathan is an eminent finance consultant. She has been associated with MyAssignmenthelp.com for decades. If you require blogs or unique solutions on the effective interest rate, feel free to contact her anytime you need.
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