Effective Annual Yield

When you go to a bank inquiring about the deposit rates, the rates specified by the bank can be expressed in two ways: nominal interest rate and the effective annual rate (also called effective annual yield).

The difference between the two is that the nominal rate does not take compounding into consideration, while the effective annual yield does.

Consider an investment of $100 at a nominal rate of 10% compounded monthly.

The future value of the investment will be:

The effective yield will be the absolute increase as a percentage of the principal invested.

Therefore, the effective annual yield will be:

Since the effective yield considers compounding effect, it will always be greater than nominal yield.

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