Microsoft Office Tutorials and References

In Depth Information

**Converting Interest Rates**

Figure 11-15:
Using the CUMIPMT and CUMPRINC functions.

Converting Interest Rates

The previous examples in this chapter use a simplified method of converting interest rates. They

use either a nominal rate that matches the payment terms nicely or an estimated rate. The

nominal rates were assumed to compound with the same frequency as the payment — say monthly.

No conversion was necessary in that case.

In the discounting examples where discount rates were estimated (such as assuming an 8%

return on your IRA), it makes no sense to convert those rates. Converting an estimated interest

rate in those examples makes it appear that there is some level of accuracy in the rate — and

there isn’t. In some situations, however, you may need to convert a rate. This section describes

different types of rates and how to convert them.

Methods of quoting interest rates

The three commonly used methods of quoting interest rates are

h
Nominal rate:
This is the quoted rate. It is quoted on an annual basis, along with a

compounding frequency per year — for example, 6% APR compounded monthly.

h
Annual effective rate:
This is the actual rate paid or earned annualized. For example, a

nominal rate of 6% APR compounded monthly results in $61.68 of interest on a $1,000

loan. That’s an effective rate of 6.168%.