Question

Given a 5-year, $1,000 loan paying 8% per year where the interest is compounded quarterly:

a) Use the FV function in Excel to calculate the total interest that would accrue.

b) What are the nominal and effective interest yields on this instrument and explain the difference between the two?

Answer 1

Present Value	1000
Interest Rate	8.00%
Term (years)	5
Compounding period per year	4
Fututre value	1,485.95
Excel formulae for the same is =FV(Interest rate/Compounding periods in one year, Term * Comp,0,-loan amount) =FV(B2/B4,B3*B4,0,-B1)

The nominal interest rate is the interest rate which signifies the actual monetary price borrowers pay lenders to use their money. Nominal rate on a loan is 8%, one can expect to pay $80 of interest for every $1000 loan. This is also called coupon rate.

Effective interest rate, considers the compounding effect. Loan pays 8% annually and compounds quarterly, so on $1,000 interest will be $20 for first quarter and $20.4 (1020*.02)for 2nd quarter.

The difference between these two is only the compounding due to which interest amount get increased bit.