stated interest rates?

CFA Level I
#1

A couple simple/silly questions:

  • Why are most (if not all) interest rates stated as nominal rates instead of effective rates if the effective rate is actually what or the lender gets?

  • I know how to annualize an interest rate, but what about revenue for instance. For example, if you have 4 months of revenue and want to ballpark what the company might have after a full year - do you just mutliply by 3??

  • When someone says to anualize a rate, how do you know that means to give them the effective annual rate [(1+r)n] or the nominal rate (simply multiplying by the # of periods in the year) ??

Thanks for the help!!

#2

- Why are most (if not all) interest rates stated as nominal rates instead of effective rates if the effective rate is actually what or the lender gets?

Because interest rates look more appealing as a nominal rate than the real return. If a bank offered you 4% in a savings account but inflation was 3%. You would more likely save money in the bank that stated they will pay a nominal rate of 4%, than a bank who said their real return rate was 0.00971% [1.04 = (1+real rate)(1.03) rearrange formula to find real rate]

Effective rate is not really related to nominal rate - the meaning is related more to how the interest is paid. For example if two banks are offering 4% in a high interest savings account if one pays interest monthly, one pays yearly and one pays quarterly - what would be the effective interest rate being offered by each bank?

- I know how to annualize an interest rate, but what about revenue for instance. For example, if you have 4 months of revenue and want to ballpark what the company might have after a full year - do you just mutliply by 3??

Maybe, most of the time the interest rate in the material is stated as an annual rate. For Bonds and LIBOR (derivatives) this is a simple interest rate and not compounded, but other areas of derivatives are compounded and most of the other Level 2 curriculum would be dealing with compounding rates.

Simple interest e.g. bonds & LIBOR is the first equation not the second (which is compound interest)

- When someone says to anualize a rate, how do you know that means to give them the effective annual rate [(1+r)n] or the nominal rate (simply multiplying by the # of periods in the year) ??

Effective and Annual rates don’t usually differ at Level 2 but if a question states what is the return in 3 months and not next year. And they have given you an annual rate. It means find the return using the second formula above and not simple interest rate.

#3

For some reason my picture of my formula is not showing up in the thread

Simple Interest = [1 + 0.4(4/12)]

Compound Interest = (1.04)(4/12)

#4

Not if you’re making deposits though. Effective would look more appealing then. Why then the choice to blanket and show nominal for lending and borrowing?