Chapter 5 Business Finance Notes

2/19/25 BUSA 3150 – Business Finance Walton


Chapter 5
Learning Objective 1-4
Annual and Periodic Interest Rates:
 Annual percentage rate (APR): The yearly uncompounded rate of
interest
o Institutions often pay interest quarterly, monthly, or even daily


 Compounding period: The period which interest is applied
 Compounding periods per year (C/Y or m): the frequency of times
interest is added to an account each year.
o For this chapter’s formula:
 If the number of compounding periods per year is 12 than:
 m=12
 If is quarterly compounding:
 M=4


 APR must be converted to periodic interest rate if an interest rate on
a loan/investment compounds more than once a year
o Periodic interest rate: the annual percentage rate divided by
the number of compounding periods per year
APR
o r=
m

 Effective Annual Rate (EAR): The rate of interest that the financial
institution actually pays or that you earn per year; it depends on the
number of compounding periods
o EAR=¿
o It is important to always convert APRs to EARs so that you know
your true return or cost of money


Nominal and Real Interest Rates:
 Nominal interest rates: The interest rate composed of a real interest
rate plus the inflation rate
o the percentage change in the actual dollars that you receive on
your investment.
o Nominal rate = real rate + expected inflation
 Real interest rate (r*): The reward for waiting
o The percentage change in the purchasing power of the dollars
received on investments.