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FM Comparing Loans

2.3 Nominal and Effective Interests

Nominal Interest

  • Interest rates are generally quoted annual rates (i.e. per year). This figure is known as the nominal interest.
  • If interest is compounded annually, this is equal to the interest per compounding period.
  • If interest is compounded more frequently however, the interest per compounding period is calculated by dividing the nominal interest by the number of compounding periods per year:

r_{\text {compounding period }}=\frac{r}{n}

Where r is the nominal interest rate and n is the number of compounding periods in a year.

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