Nominal Interest Rate

Short Answer
The nominal interest rate is the stated rate on a loan or investment before adjusting for inflation or compounding frequency.

Nominal Interest Rate

Definition

The nominal interest rate refers to the percentage interest rate stated on a loan or investment without accounting for inflation or compounding frequency. It represents the rate charged or earned on a financial product based on the initial principal amount. Nominal interest rates are used to calculate the total interest paid or earned over a specified period. However, they do not reflect the real purchasing power of money over time because they do not adjust for inflation. To compare the true cost or return of investments across different periods or economic environments, nominal rates must be adjusted for inflation to derive the real interest rate.

Nominal Interest Rate

Examples

Bank Loan:

  • A bank offers a personal loan at a nominal interest rate of 5% per year. If inflation is 2%, the real interest rate would be lower after adjusting for inflation.
  • Bond Investment:
    • An investor purchases a corporate bond with a nominal interest rate of 7% annually. The actual return depends on prevailing inflation rates and compounding intervals.
  • Savings Account:
    • A savings account advertises a nominal interest rate of 2% per annum. The actual purchasing power gained depends on how inflation affects the value of the money saved.

    • Nominal Interest Rate

    Further Reads

    Books:

    • "Investments" by Zvi Bodie, Alex Kane, and Alan J. Marcus
      • Covers various aspects of investments, including interest rates and their impact on investment returns.
    • "Financial Markets and Institutions" by Frederic S. Mishkin and Stanley Eakins
      • Discusses the role of interest rates in financial markets, including nominal and real interest rates.
  • Articles and Online Resources:
    • Investopedia: Nominal Interest Rate
      • Provides a detailed explanation of nominal interest rates, their calculation, and significance in finance.
    • Federal Reserve Bank of St. Louis: Understanding Nominal and Real Interest Rates
      • Offers insights into how nominal interest rates are adjusted for inflation to determine real interest rates.
  • Websites:
    • Bankrate
      • Provides current nominal interest rates on various financial products, along with tools for calculating interest payments.
    • World Bank Data
      • Offers data on nominal interest rates globally, including historical trends and comparisons across countries.
  • Courses:
    • Coursera: Finance for Everyone: Smart Tools for Decision-Making
      • Covers financial concepts, including interest rates, their types, and implications for personal and business finance.
    • edX: Economics of Money and Banking
      • Explores monetary economics, including interest rate determination and its impact on economic activities.

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