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What is the difference between Compound Interest and Effective Interest?
Is it also true that effective interest is called real interest if there was no inflation?Please also correct whether I’m using the correct formulas for both interest:
Compound Interest formula = P (1 + r/n)^nt
Effective Interest formula = (1 + i/n)^n -1
Compound interest is when interest is earned on interest – if interest is 2% per month, then at the end of one month the balance will be higher because of the interest and so the interest the next month will be 2% of a higher amount.
Effective interest is calculating the true interest rate per year from (for example) the monthly interest rate.
Do not simply learn formulas but make sure you understand what is happening. The examiner deliberately asks questions that check your understanding as opposed to having simply learned rules.
This is all explained in my free lectures on interest. The lectures are a complete free course for Paper MA and cover everything needed to be able to pass the exam well.
I know what is Compound Interest (thanks to your lecture :)) but this is what I get from your answer (please correct me if I am wrong!)
1) If the annual interest rate is 12% then it is called effective interest rate because it is based on annual rate not monthly or quarterly. BUT why it is referred to as a nominal interest rate?
However, if we break down the annual rate on monthly basis then we have to divide it by 12 such as 12%/12 = 1% every month is charged by the bank
2) Is it true that it is the bank that offered bank loans to companies based on simple interest or compound interest. It is the bank that dictates these terms to companies who are willing to take up the loans they have to comply with the terms of the bank. correct?
3) Please correct the formula that I asked you previously is correct or not because I thought that both of the formulas are the same but given in different ways! Please tell me this.
I have watched the lecture on simple & compound interest. Thank you for that…
Given that you are asking exactly the same questions as ‘account guy’ (who I assume is therefore known to you!), I suggest that you read my replies to him.
As I also replied to ‘account guy’ you are presumably using a Revision Kit from one of the ACCA Approved Publishers (which you must do if you are to pass the exam) and so ask about any specific questions that are causing you a problem.
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