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Effective Interest Rate Formula:
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The Effective Interest Rate (EIR) represents the actual annual interest rate when compounding is taken into account. It provides a more accurate measure of the true cost of borrowing or the true return on investment compared to the nominal rate.
The calculator uses the daily compounding formula:
Where:
Explanation: The formula calculates the effective annual rate by accounting for the effect of compounding interest daily throughout the year.
Details: Understanding the effective interest rate is crucial for comparing different financial products, making informed investment decisions, and accurately assessing the true cost of loans or credit products.
Tips: Enter the nominal annual interest rate as a decimal (e.g., 0.05 for 5%). The calculator will compute the effective interest rate with daily compounding.
Q1: What's the difference between nominal and effective interest rates?
A: The nominal rate doesn't account for compounding, while the effective rate reflects the actual annual rate including compounding effects.
Q2: How does daily compounding affect the effective rate?
A: Daily compounding results in a higher effective rate compared to less frequent compounding, as interest is calculated and added more frequently.
Q3: Can I use this for different compounding frequencies?
A: This specific calculator is designed for daily compounding. Different formulas are needed for other compounding frequencies.
Q4: How do I convert percentage to decimal?
A: Divide the percentage by 100 (e.g., 5% becomes 0.05).
Q5: Why is EIR important for borrowers and investors?
A: EIR allows for accurate comparison between financial products with different compounding frequencies, helping make better financial decisions.