Effective Annual Interest Rate

AAA

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

INVESTOPEDIA EXPLAINS'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.

VIDEO

Loading the player...
RELATED TERMS
  1. Nominal Interest Rate

    The interest rate before taking inflation into account. The equation ...
  2. Real Interest Rate

    An interest rate that has been adjusted to remove the effects ...
  3. Fixed Interest Rate

    An interest rate on a liability, such as a loan or mortgage, ...
  4. Interest Rate Ceiling

    The maximum interest rate that a financial institution can charge ...
  5. Variable Interest Rate

    An interest rate on a loan or security that fluctuates over time, ...
  6. Compounding

    The ability of an asset to generate earnings, which are then ...
Related Articles
  1. Investing

    The Effective Annual Interest Rate

    The effective annual interest rate is a way of restating the annual interest rate so that it takes into account the effects of compounding.
  2. Economics

    Forces Behind Interest Rates

    Get a deeper understanding of the importance of interest rates and what makes them change.
  3. Retirement

    Understanding Credit Card Interest

    Paying these rates can impact your disposable income and your investment returns.
  4. Investing Basics

    Interest Rates And Your Bond Investments

    By understanding the factors that influence interest rates, you can learn to anticipate their movement and profit from it.
  5. Economics

    The True Unemployment Rate: U6 Vs. U3

    Learn how to distinguish between the U-3 and U-6 unemployment rates, and explore which rate provides a truer picture of unemployment.
  6. Stock Analysis

    The Top Performing Airlines Right Now

    Learn about the airline industry and its top-performing companies. Understand these top-emerging airlines and why they have taken more market share.
  7. Economics

    What Is a Quota?

    In business, quota usually refers to the sales target for a salesperson or a sales team.
  8. Economics

    What Does Infrastructure Mean?

    Examples of infrastructure include mass transit, communication, sewage, water and electric systems, plus roads, bridges and tunnels.
  9. Economics

    Calculating the GDP Price Deflator

    The GDP price deflator adjusts gross domestic product by removing the effect of rising prices. It shows how much an economy’s GDP is really growing.
  10. Economics

    What's a Centrally Planned Economy?

    A centrally planned economy is one where the government controls the country’s supply and demand of goods and services.
RELATED FAQS
  1. How do nominal interest rates in finance differ from the nominal rate of interest ...

    Despite being incredibly similar in title, a financial instrument's nominal interest rate is something very different than ... Read Full Answer >>
  2. What are the advantages of using an effective interest rate figure?

    The primary advantage of using the effective interest rate figure is simply that it is a more accurate figure of actual interest ... Read Full Answer >>
  3. What is the rationale behind the effective interest rate?

    There are several different effective interest rates. In accounting, the effective interest method examines the relationship ... Read Full Answer >>
  4. When has the United States run its largest trade deficits?

    In macroeconomics, balance of trade is one of the leading economic metrics that determines the trading relationship of a ... Read Full Answer >>
  5. How does the bond market react to changes in the Federal Funds Rate?

    The bond market is highly sensitive to changes in the federal funds rate. When the Federal Reserve increases the federal ... Read Full Answer >>
  6. Which is more important to a nation's economy, the balance of trade or the balance ...

    There is no question the composition of a country's balance of payments is more important than its balance of trade. This ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Nanny Tax

    A federal tax that must be paid by people who hire household help (a babysitter, maid, gardener, etc.) and pay them a total ...
  2. Dog And Pony Show

    A colloquial term that generally refers to a presentation or seminar to market new products or services to potential buyers.
  3. Topless Meeting

    A meeting in which participants are not allowed to use laptops. A topless meeting organizer can also ban the use of smartphones, ...
  4. Hedging Transaction

    A type of transaction that limits investment risk with the use of derivatives, such as options and futures contracts. Hedging ...
  5. Bogey

    A buzzword that refers to a benchmark used to evaluate a fund's performance. The benchmark is an index that reflects the ...
  6. Xetra

    An all-electronic trading system based in Frankfurt, Germany. Launched in 1997 and operated by the Deutsche Börse, the Xetra ...
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!