Effective Interest Rate Key Terms
Learn the ABCs of effective interest rate key termsThe effective interest rate is used as a calculation to determine a more accurate interest rate over a period of time. Investment interest rates, also called effective interest rates, are determined for a period of time or life of the investment.
In the opposite token, as a borrower, the effective interest rate is the annual rate of interest you will pay on a loan. If you understand the basic investing and borrowing terms that go with effective interest rates, you'll be able to better understand how interest will affect your investments or loans.
Annual equivalent rate (AER)The annual equivalent rate, or AER, is calculated by using the effective interest rate. Loans with interest compounded at different intervals like daily, weekly or quarterly or annually are hard to compare. The AER converst these rates to an annual rate to make it easily compared.
Rate swapAn interest rate swap takes place when one interest rate is exchanged for a different one. Each is based on the same principal amount, but can change the way a loan is paid by lowering interest or changing to a floating payment option.
Simple interest and compound interestSimple interest is calculated using a single percentage of the principal amount, while compound interest is that paid on the principal plus previously paid interest amount.
Compound growth rateThe compound growth rate is a measurement of average growth over a set time. The assumption made with this figure is that the rate is constant in growth over time. The rate doesn't show big gains or losses in rate so it can be misleading.
Nominal interest rateA nominal interest rate is one that does not adjust for inflation. A nominal rate can be calculated easily without adjusting to figure the effective interest rate.
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