Kinds of Interest Rates - Nominal Rate, Periodic Rate, Effective Annual Rate.

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Kinds of Interest Rates

Let's say I give you a credit card and the interest rate on the card is 3% per month. What is the annual rate that you are actually charged?? 36%?? Well, no. It's actually 42.57%.

Nominal Rate	Nominal means "in name only". This is sometimes called the quoted rate.
Periodic Rate	The amount of interest you are charged each period, like every month.
Effective Annual Rate	The rate that you actually get charged on an annual basis. Remember you are paying interest on interest.

In the example

The Nominal Rate is 36%.
The Periodic Rate is 3% (you are charged 3% interest on your balance every month)
The Effective Annual Rate is 42.57%

Nominal Rate = Periodic Rate X Number of Compounding Periods

Effective Annual Rate = (1+ i / m)^m -1

m = the number of compounding periods
i = the nominal interest rate

O.K., so let's try the example again.

Effective Annual Rate = (1+ i / m)^m -1
Effective Annual Rate = ( 1 + .36 / 12 )¹² -1
Effective Annual Rate = (1.03)¹² - 1
Effective Annual Rate = (1.4257) -1
Effective Annual Rate = .4257
Effective Annual Rate = 42.57 %