What is effective yield - Definition and Meaning

Effective Yield :

Effective Annual Rate is used to find out the actual annual rate that would be paid on a loan if the specified annual rate is affected by compounding.


Formula :

i = [1 + (r/n)]n - 1 Where, r = Nominal Annual Interest Rate n = Number of payments per year i = Effective Interest Rate

Example :

Annual interest rate is 10% compounded monthly payments, what is the effective interest rate? Effective Interest Rate (i) = [1 + (r/n)]n - 1 = [1 + (0.1/12)]12 - 1 = [1 + 0.008333]12 - 1 = 1.104713063 - 1 = 0.104713063 x 100 Effective Interest Rate (i) = 10.4713 %

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