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This function allows you to compare
interest rates quoted on different bases. Interest rates are typically quoted as a rate
together with a compounding period, such as "12% compounded monthly", or
"10% compounded quarterly". Rates quoted in this way are called Annual
Nominal Rates. In practice, the Annual Nominal Rate is divided by the
compounding period, and that percentage of interest is paid or received each period. For
instance, investing in a savings account paying 12% compounded monthly means that you
receive 1/12 of 12%, or 1%, interest each month.
This 12% Nominal Rate is different from the Effective Annual Rate, which
measures the annual rate of increase in an investment. In the 12% investment example, if
you reinvested the 1% interest you receive each month, the monthly compounding (interest
on interest) means that the amount in the account at the end of a year is 12.6825% greater
than at the beginning of the year. Thus, 12% compounded monthly is "equivalent"
to 12.6825% compounded annually.
This function shows 14 equivalent rates, expressed as Annual Nominal Rates in the left
hand column, and Annual Effective Rates in the right hand column. You may type any rate of
60% or less into any of the rates, and the corresponding equivalent rates will be computed
and filled in on the screen.
As an example of using this function in real life, banks try to convince us to save at
their institution because it is safe and they offer the "best" interest rates.
They usually tell us the current rate and method of compounding interest. One may say they
pay 12% compounded monthly and another compounds daily at 11.8%. Which is the better deal?
This function shows you that 12% compounded monthly is equivalent to 11.9424% compounded
daily, so 12% compounded monthly is better than 11.8% compounded daily.
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