Question

An item you're looking at purchasing is available on a monthly payment plan (i.e you make monthly payments on it).

The nominal rate given is 5.9% nomainal yearly, compounded monthly.

Would you use the effective rate in this case or the nominal rate? What would have to change in this problem for you to use the nominal rate?

Answer 1

An item you're looking at purchasing is available on a monthly payment plan (i.e you make monthly payments on it).

The nominal rate given is 5.9% nomainal yearly, compounded monthly.

Would you use the effective rate in this case or the nominal rate? What would have to change in this problem for you to use the nominal rate?

First of all we have to understand that the interest rate takes two forms viz Nominal interest rate and the effective interest rate.The NIR (nominal interest rate rate ) does not include the compounding period while the effective rate of interest includes the compounding period and it is provide more accurate measures of the interest rates /charges . Now suppose that I.R is 5.9 % in this case which is nominal interest rate for a product i purchased and the effective interest will be also be 5.9 % but the compounding will be greater in effective interest rate , and therefore the more frequent the compounding occurs , the more will be the interest rate ( effective ) .So i will use ffective interest rate instead of nominal interest rate in this case .

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