An investor can invest money with a particular bank and earn a stated interest rate of 4.40%; however, interest will be compounded quarterly. What are the nominal, periodic, and effective interest rates for this investment opportunity

Answer: 1. 4.40%

2. 1.10%

3. 4.47%

Explanation

1. Nominal Interest Rate

The Nominal Interest rate is the same as the stated interest rate as it is without having adjusted for any compounding effects. It is therefore 4.40%.

2. Periodic Interest Rate

This rate refers to the stated interest rate divided by the number of periods in the year. As the interest is compounded quarterly, it means there are 4 periods in the year.

The periodic rate is;

= 4.4 / 4

= 1.10%

3. The Effective Interest Rate

This rate takes into account the effect of compounding in a period. The formula is given by;

Effective Interest rate = ((1 + stated interest / m) ^ m) - 1

Where m = compounding periods

= (1 + 4.4%/4) ⁴ - 1

= 4.47%