The number of compounding periods in one year is called compounding frequency. The compounding frequency affects both the present and future values of cash flows. An investor can invest money with a particular bank and earn a stated interest rate of 8.80%; however, interest will be compounded quarterly. What are the nominal, periodic, and effective interest rates for this investment opportunity

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hyderali230 hyderali230 · Answer 1 · 2020-04-09T05:50:43+02:00

Answer:

Nominal = 8.8% yearly

Periodic = 2.2% quarterly

Effective = 9.09% compounded Quarterly

Explanation:

Bank issues the nominal Interest rate, so, 8.8% interest rate issued by the bank is the nominal.

Periodic interest rate is the interest rate for a specific period. It is calculated by dividing the annual rate with numbers of period in a year.

8.8% Interest rate is annual rate, to calculate the quarterly rate we divide it by 4.

Interest per quarter = 8.8% / 4 = 2.2%

Effective interest rate included the compounding effect.

Interest is compounded each Quarter

Effective Interest rate = ( 1 + r ) ^n = [ ( 1 + 8.8%/4 )^4 ] - 1 = 9.09%