by Nominal Interest rate refers to the interest rate without the adjustment of inflation. It is basically the rate “as stated”, “as advertised” and so on which does not take inflation, compounding effect of interest, tax or any fees in the account.
It is also known as Annualized Percent Rate. This is the interest compounded or calculated once in a year.
Mathematically, it can be calculated using the below formula is represented as below
Nominal interest rate formula = [(1 + Real interest rate) * (1 + Inflation rate)] – 1
- Real Interest Rate is the interest rate that takes inflation, compounding effect and other charges into account.
- Inflation is the most important factor that impacts the nominal interest rate. It increases with inflation and decreases with deflation.
Applications
It is widely used in banks to describe interest on various loans.
It is widely used in the investment field to suggest investors for various investment avenues present in the market.
For example, Car loan available at 10% of interest rate. This face an interest rate of 10% is the nominal rate. It does not take fees or other charges in an account.
Bond available at 8% is a coupon rate as it does not consider current inflation. This face interest of 8% is the nominal rate.
