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Can you please tell me the differences between nominal, real, and effective rates are important when it comes to loans
They are related to the cost of capital.
The nominal cost of capital is the actual cost of capital. The real (or effective) rate is the cost of capital if there was no inflation.
It is the Fisher formula (provided in the exam) that gives the relationship between the two.
This is all explained in my free lectures on investment appraisal with inflation.
Thanks for your reply 🙂
I know that the real interest rate will be given in the exam but if you don’t mind asking me that the effective interest rate (i.e. real interest rate) can be calculated by this formula or not. Is that correct or not?
Effective Interest formula = (1 + i / n)^n -1
It all depends which topic you are asking about.
For cost of capital calculations the real interest rate means the rate without inflation.
The formula you quote is the effective annual interest and is relevant when looking at the management of receivables and payables and calculating the cost of benefit of giving or receiving discounts.
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