Effective Rate of Interest when Compounded Monthly

Nominal rate of interest is the rate of interest that is mentioned on the loan or investment document. It is the rate at which interest is charged or paid without considering the compounding effect. However, the effective rate of interest is the actual rate at which the investment grows or the loan amount increases after considering the effect of compounding.

Calculating the Effective Rate of Interest

To calculate the effective rate of interest when the nominal rate of interest is compounded monthly, we use the formula:

Effective Rate of Interest = (1 + (Nominal Rate of Interest/12))^12 - 1

Where,

Nominal Rate of Interest = 9.9% per annum
Compounding Frequency = Monthly

Now, we can substitute the values in the formula to get:

Effective Rate of Interest = (1 + (9.9%/12))^12 - 1
Effective Rate of Interest = (1 + 0.825%)^12 - 1
Effective Rate of Interest = (1.00825)^12 - 1
Effective Rate of Interest = 10.47%

Therefore, the effective rate of interest when the nominal rate of interest is 9.9% per annum and is compounded monthly is 10.47% per annum.

Conclusion

Through this calculation, we can conclude that the effective rate of interest is higher than the nominal rate of interest due to compounding. The more the compounding frequency, the higher will be the effective rate of interest. Thus, it is important to consider the effective rate of interest while making investment decisions or taking loans.

10.36%