Effective Annual Interest Rate

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DEFINITION of 'Effective Annual Interest Rate'

An investment's annual rate of interest when compounding occurs more often than once a year. Calculated as the following:

 

Effective Annual Interest Rate

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BREAKING DOWN 'Effective Annual Interest Rate'

Consider a stated annual rate of 10%. Compounded yearly, this rate will turn $1000 into $1100. However, if compounding occurs monthly, $1000 would grow to $1104.70 by the end of the year, rendering an effective annual interest rate of 10.47%. Basically the effective annual rate is the annual rate of interest that accounts for the effect of compounding.

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RELATED FAQS
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    Despite being incredibly similar in title, a financial instrument's nominal interest rate is something very different than ... Read Full Answer >>
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