Nominal Rate of Interest v.01

Nominal rate of interest and
discount
Dina Agustina, S.Pd., M.Sc.
Mathematics Study Programme

Universitas Negeri Padang
2021
Nominal Rate of Interest and Discount
• You have known about effective rate of interest.
• If we have case, in one year the interest is paid more often.

This case is called the nominal rate of interest
• The notation of nominal rate is 𝒊(𝒎)

• 𝑖 (𝑚) : nominal rates of interest payable 𝑚 times per period, where 𝑚 > 1.
• We use the term “Payable”, “Compounded” and “Convertible” to
express the interest is paid more frequently
Ex: A nominal rate of 8% convertible quarterly does not mean an interest rate of 8%
per quarter but rather than an interest rate of 2% per quarter. 𝑚 𝑚
𝑖
𝑃 1+
8% 2% 2% 2% 2% 𝑚
P = 𝑃(1 + 𝑖)
P P(1+i)
0 1 23 4
0 1 =1
4 44 4
𝑚 𝑚 𝑚
𝑚 𝑖 1
𝑖
1+𝑖 = 1+ 𝑖 = 1+ −1 𝑖 𝑚 =𝑚 1+𝑖 𝑚 −1
𝑚 𝑚
Illustration of nominal rates of interest

Time 0 𝟏 𝟐 … 𝒎−𝟏 𝒎
=𝟏
𝒎 𝒎 𝒎 𝒎
Interest 𝑚 𝑚 𝑚 … 𝑚−2 𝑚−1
𝑖 𝑖 𝑖 𝑖 𝑚 𝑖 𝑚 𝑖 𝑚 𝑖 𝑚
.1 1+ 1+ 1+
𝑚 𝑚 𝑚 𝑚 𝑚 𝑚 𝑚
𝑖 𝑚 2 𝑚−1 𝑚
Balance 1 1+ 𝑖 𝑚 … 𝑖 𝑚 𝑖 𝑚
𝑚 1+ 1+ 1+ =1+𝑖
𝑚 𝑚 𝑚
Nominal rate of Discount 𝒅 (𝒎)
𝑚 𝑚
𝑑 𝑚 𝑑𝑚 1 1
1−𝑑 = 1− 𝑑 =1− 1− 𝑑 𝑚
=𝑚 1− 1−𝑑 𝑚 − 1 = 𝑚[1 − 𝑣𝑚 ]
𝑚 𝑚
Illustration of nominal rates of discount

Time 0 𝟏 … 𝟐 𝒎−𝟏 𝒎
=𝟏
𝒎 𝒎 𝒎 𝒎
𝑚−1 𝑚−2
discount 𝑑𝑚 𝑑𝑚 𝑑𝑚 𝑑𝑚 … 𝑑𝑚 𝑑𝑚 𝑑𝑚
. 1− . 1− 1− .1
𝑚 𝑚 𝑚 𝑚 𝑚 𝑚 𝑚
𝑚 𝑚−1 2
Balance 𝑑𝑚 𝑑𝑚 … 𝑑𝑚 𝑑𝑚 1
1−𝑑 = 1− 1− 1− 1−
𝑚 𝑚 𝑚 𝑚
Types of Interest, Multiple Payments, and
Symbols.
The number of payments in Symbol for interest
Types of Interest a year rates (generally)
Annual Once i
Convertible Semi-annual 2 times 𝑖 (2)
Convertible 4 months 3 times 𝑖 (3)
Convertible Quarterly 4 times 𝑖 (4)
Convertible 2 months 6 times 𝑖 (6)
Convertible Monthly 12 times 𝑖 (12)
Convertible Weekly 52 times 𝑖 (52)
Convertible Daily 360 or 365 times 𝑖 (360) or 𝑖 (365)
Continue infinite 𝛿
Find the accumulated value of $𝟓𝟎𝟎 invested for five years at 8% per annum
convertible quarterly.
Given:
𝑷 = $𝟓𝟎𝟎
𝒕=𝟓
𝒊(𝒎) = 𝒊(𝟒) = 𝟖%
Ask: 𝐀𝐕 = 𝒂 𝟓 =?
Solution
𝒎 𝒎.𝒕 𝟒.𝟓
𝒊 𝟎. 𝟎𝟖
𝒂 𝟓 =𝑷 𝟏+ = 𝟓𝟎𝟎 𝟏 + = $𝟕𝟒𝟐. 𝟗𝟕
𝒎 𝟒
Find the present value of $𝟏𝟎𝟎𝟎 to be paid at the end of six years at 6% per annum
payable in advance and convertible semiannually.
Given:
𝑷 = $𝟏𝟎𝟎𝟎
𝒕=𝟔
𝒊(𝒎) = 𝒊(𝟐) = 𝟔%
Ask: 𝐏𝐕 = 𝒂−𝟏 𝟔 =?
Solution
𝒎 𝒎.𝒕 𝟐.𝟔
𝒊 𝟎. 𝟎𝟔
𝒂 𝟓 = 𝟏𝟎𝟎𝟎 𝟏 + = 𝟏𝟎𝟎𝟎 𝟏 − = $𝟕𝟒𝟐. 𝟗𝟕
𝒎 𝟐
Forces of interest
• Interest can be calculated every hour, every minute, every second and
so on until infinity which means interest is paid every time. This is
called forces of interest. If nominal rate with the value m→∞ (i(m) =
δ), we get the result
𝑚𝑡
𝑖 (𝑚)
AV = lim 1 + = 𝑒 𝛿𝑡
𝑚→∞ 𝑚
• If forces of interest have the constant value during the period 0 ≤ 𝑡 ≤ 𝑛,
𝛿𝑡 = 𝛿 then we get the accumulation value
n
a ( n)  e 0
 dt
 e n
We known that 𝑎 𝑛 = 1 + 𝑖 𝑛 . So, the relationship between the
effective rate of interest (𝑖) and forces of interest 𝛿 as follow
eδn = (1+i)n,
i = eδ-1,
δ = ln (1+i)
If forces of interest 6%, determine the corresponding annual effective rate of
interest?
Given:
𝛿 = 6%
𝑡=1
Ask: 𝑖 = ⋯ ?
Solution:
i +1= eδt
1+i = e0,06
i = e0,06 – 1 = 0,06184
The basic problem in interest cases
• The principal originally invested
• The length of the investment period
• The rate (or force) of interest (or discount)
• The accumulated value of the principal at the end of the investment
period.
Equation of Value
• Time value of money
In return for a promise to receive $600 at the end of 8 years, a person agrees to pay
$100 at once, $200 at the end of 5 years, and to make a further payment at the end
of 10 years. Find the payment at the end of 10 years if the nominal rate of interest is
8% convertible semiannually
Solution: 𝑖 (2) = 4%
100 200 𝑋
𝟏𝟎𝟎 + 𝟐𝟎𝟎𝒗𝟏𝟎 + 𝑿𝒗𝟐𝟎 = 𝟔𝟎𝟎𝒗𝟏𝟔
0 1 2 4 5 6 7 8 9 10
3
600 600𝑣 16 − 100 − 200𝑣 10
𝑋=
𝑣 20
𝑋 = $186.76
The other way:
100 200 𝑋
0 1 2 3 4 5 6 7 8 9 10 𝑖 (2) = 4%
600
100 1.04 20 + 200(1.04)10 +𝑋 = 600(1.04)16
𝑋 = $186.76

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Nominal rate of interest and

Dina Agustina, S.Pd., M.Sc.

Mathematics Study Programme

• If we have case, in one year the interest is paid more often.

• The notation of nominal rate is 𝒊(𝒎)

Illustration of nominal rates of interest

Illustration of nominal rates of discount

100 1.04 20 + 200(1.04)10 +𝑋 = 600(1.04)16

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