Nominal Rates of Interest and Discount

When compounding/discounting has to be done a: intervals less than a year, a distinction should be made between (i) nominal and (iii) effective rates of interest. The coupon rate of interest is ‘called the nominal rate of interest. The nominal rate of interest differs from the effective rate of interest due to the frequency of compounding (e.g. annual, half-yearly, quarterly, monthly) with the nominal rate. With annual compounding/conversion, the nominal rate and the effective rate would be the same. The effective rate of interest is higher and increases with an increase in the frequency of compounding. Consider Example 2-A.2 .

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