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I have got few questions related to interest rate after watching your lecture…
1) Is it true that nominal interest rate is always quoted by bank (government or other institutions etc) by which we can calculate the total interest amount.
2) What is APR and why is it quoted by bank?
3) What is the difference between nominal interest and effective interest. What makes an effective interest?
4) Why investors calculate the difference between nominal interest and APR?
5) Why investors calculate the difference between nominal interest and real interest? What is the difference between two?
6) Is it true that nominal interest is consist of real interest and inflation rate as explained by Fisher model but what does it explain?
7) Nominal interest does not account for inflation while real interest does. That’s why when we calculate the nominal interest using fisher formula then we have add the inflation in it.
6) Is it true that compounding means how many times in a year we have to pay or receive interest in case of borrowing and investment?
Please explain this to me. I am totally stuck with them ?
1. Any lender will always state what interest they will be charging – the borrower obviously needs to know what they will be paying!
2 and 3. The APR is the effective annual rate. Lenders are required by law to state what the effective rate is so that borrowers know the true interest they will be paying.
For example, a lender might be charging interest of 2% a month. A borrower might therefore think that it is the same as 12 x 2 = 24% per year. However because of interest being compounded it actually comes to more than 24% per year. The ‘true’ annual interest is the APR or effective rate (just as explained in example 4 of my lecture).4 and 5 The don’t calculate the difference. They need to know what the effective rate is for the reasons above.
6 and 7 The Fisher model is not examinable in Paper MA. It is not relevant until Paper FM.
8 Compounding is the idea of interest being charged on interest and is explained in full in my lecture.
Sir I passed both exams (MA and FM) but I don’t recall the Fisher model clearly. If you don’t mind could you please help me with points 5 , 6 and 7?
Secondly, when we use compounding formula we always see how many times in a year an interest is being compounded which refers to how many times we have to pay or receive interest in case of borrowing and investment which denotes by (n) in the given formula below.
Compound interest = (1+r)^n
Is that correct?
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