Effective
Interest Rate
Effective Interest Rate is
calculated with the help of following formula.
1+R= (1+i) n
R= Rate of Interest
I= Rate of interest for period (months,
quarter, semiannual)
n= Number of periods (months, quarter, semiannual)
in year
Effective
Interest Rate Example
A got a credit card from a
reputable bank and bank offered him a 3% interest per months. Credit card
amount was $ 10,000. Calculate the interest for the year?
R = (1+i) n-1
= (1.03)12-1
=1.4257-1
=.4257
=
42.57%
Interest amount = 10,000 x 42.57 %
=$ 4,257
Purpose
of effective Interest Rate
Effective interest rate gives you annual
interest cost and an effective tool to measure the different financial product.
Effective interest rate takes into account the periodical compounding effect.
