Hi Guys, I have come across a confusing understanding of the questions. See below as an example. The questions will state an interest rate however I have to divide by 12 to get the answer for the monthly interest rate. The question already says compounded monthly so why am I having to divide this by 12 even though surely it takes it into account in the question?
A person borrows $z amount with repayment of 40 years with payments made monthly. With an interest rate of x%, COMPOUNDED MONTHLY. Please solve.
Hey S2000magician,
Hope you’re doing great.
I have a question though (5 years later ), if i want to go from the monthly rate found by dividing the annual rate, i’ll logically just have to multiply it by 12. But i don’t understand why wouldn’t i compound it, like (1 + monthly rate)^(12), is it because it is not said that it is compounded monthly?
I guess:
10% quoted annual rate compounded annually, will give us 0,10/12 monthly.
10% quoted annual rate compounded monthly, will still give us 0,10/12 monthly, but an EFFECTIVE ANNUAL RATE of [1 + (0,1/12)] ^ (12)
It’s a matter of how the rate is quoted: as a nominal rate or as an effective rate.
In the US, at least, most interest rates are quoted as nominal (annual) rates. If I had to guess why, I’d say the reason is that the numbers come out lower, so they look more attractive to borrowers. A 3.50% (annual, nominal) mortgage rate sounds better than a 3.5567% (annual, effective) rate.
), if i want to go from the monthly rate found by dividing the annual rate, i’ll logically just have to multiply it by 12. But i don’t understand why wouldn’t i compound it, like (1 + monthly rate)^(12), is it because it is not said that it is compounded monthly?