Principal and Interest Definition Effective interest rate is the equivalent yearly interest rate that would produce the same result after 1 year without compounding. Example An annual rate of 8%compounded quarterly will produce an increase of (1.02)41.0824;hence the effective interest rate is 8.24%.The basic yearly rate(8%in this example)is termed the nominal rate. Compounding can be carried out with any frequency. The general method is that a year is divided into a fixed number of equally spaced periods,say,m periods.The effective interest rate is the numberr' that satisfies 1+r=(+) Xi CHEN (chenxi0109@bfsu.edu.cn) Investment Science 10/174Principal and Interest Definition Effective interest rate is the equivalent yearly interest rate that would produce the same result after 1 year without compounding. Example An annual rate of 8% compounded quarterly will produce an increase of (1.02)4 ≈ 1.0824; hence the effective interest rate is 8.24%. The basic yearly rate (8% in this example) is termed the nominal rate. Compounding can be carried out with any frequency. The general method is that a year is divided into a fixed number of equally spaced periods, say, m periods. The effective interest rate is the number r 0 that satisfies 1 + r 0 =  1 + r m m . Xi CHEN (chenxi0109@bfsu.edu.cn) Investment Science 10 / 174