Converting Nominal Interest Rates to Different Compounding Periods
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Sometimes the compounding period of the interest on a loan will not match the when deposits are expected to be made. For example, you are expected to make monthly mortgage payments, but the interest is compounded semi-annually. In cases like these, we must convert the nominal rate to an equivalent rate that matches the timing of the cash flows.
Q1. Find the equivalent rate of interest for a loan rated at 8% compounded semi-annually to interest compounded annually.
Note: When finding the equivalent annual rate, it is called the effective annual rate.
Q2. Find the equivalent rate of interest for a loan rated at 3.5% compounded monthly to interest compounded semi-annually.