Microsoft Office Tutorials and References

In Depth Information

**Using EFFECT to Calculate the Effect of Compounding Period on Interest Rates**

Using

Using
EFFECT

EFFECT
tto Calculate

Calculate the

the Effect

Effect oof Compounding

Compounding Period

Period oon Interest

Interest

Rates

Rates

Does it really matter if your bank compounds interest daily, monthly, or

quarterly? If the numbers are big enough, it can matter. The EFFECT function

converts an interest rate to an effective rate, depending on how frequently

the bank compounds the interest.

Syntax

EFFECT(nominal_rate,npery)

The EFFECT function returns the effective annual interest rate, given the

nominal annual interest rate and the number of compounding periods per year.

This function takes the following arguments:

•
nominal_rate

nominal_rate
—
This is the nominal interest rate.

•
npery

npery
—
This is the number of compounding periods per year. npery is

truncated to an integer.

If either argument is nonnumeric, EFFECT returns a #VALUE! error. If nomin-

al_rateis less than or equal to 0 or if nperyis less than 1, EFFECT re-

turns a #NUM! error.

In
Figure 13.9
, the nominal interest rate is 4%. If the bank compounds interest

once per year, the effective interest rate is still 4%, as shown in cell A5.

If interest is compounded monthly, the effective rate increases to 4.07%. Row

9 compares the monthly mortgage payment at the various effective rates.

Daily compounding adds about $10 per month to a typical mortgage payment.