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ANALYSIS IN CONSTRUCTION
Chapter III- Nominal and Effective
Interest Rates
By
Assoc. Prof. Dr. Ahmet ZTA
GAZANTEP University
Department of Civil Engineering
- Single Amounts
- Series: PP >= CP
- Series: PP < CP
Using spreatsheets
CE 533 Economic Decision Analysis 2 / 54
Example:
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(3.1)
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(2)
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3.2 Example 1:
Given:
interest is 8% per year compounded
quarterly.
What is the true annual interest rate?
Calculate:
i = (1 + 0.08/4)4 1
i = (1.02)4 1 = 0.0824 = 8.24%/year
CE 533 Economic Decision Analysis
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3.2 Example 2:
Given: 18%/year, comp. monthly
What is the true, effective annual
interest rate?
r = 0.18/12 = 0.015 = 1.5% per month.
1.5% per month is an effective monthly
rate.
The effective annual rate is:
(1 + 0.18/12)12 1 = 0.1956 = 19.56%/year
CE 533 Economic Decision Analysis
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i = er 1
Where r is the nominal rate of interest
compounded continuously.
This is the max. interest rate for any value of
r compounded continuously.
CE 533 Economic Decision Analysis
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r ln(1 i )
CE 533 Economic Decision Analysis
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er 1 = 0.15
er = 1.15
ln(er) = ln(1.15)
r = ln(1.15) = 0.1398 = 13.98%
A rate of 13.98% per year, cc. generates the same
as 15% true effective annual rate.
CE 533 Economic Decision Analysis
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Alternatively, it is always
correct to determine the effective i
per payment period using
Equation [3.2] and to use
standard factor equations to
calculate P, F, or A.
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(compounded monthly)
Let P = $1500.00
Find F at t = 2 years.
15% c.m. = 0.15/12 = 0.0125 =
1.25%/month.
n = 2 years OR 24 months
Work in months or in years
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F24 = $1,500(F/P,0.15/12,24);
F24 = $1,500(F/P,1.25%,24);
F24 = $1,500(1.0125)24 =
$1,500(1.3474);
F24 = $2,021.03.
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F24 = $1,500(F/P,i%,2);
i/month =0.0125
F2 = $1,500(F/P,16.08%,2)
F2 = $1,500(1.1608)2 = $2,021.19
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3.4 Example 2.
F 10 = ?
Consider
r = 12%/yr, c.s.a.
0
$1,000
10
$1,500
$3,000
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3.4 Example 2.
F 10 = ?
$1,000
10
12
14
16
18
20
$1,500
$3,000
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3.4 Example 2.
F 20 = ?
Compound Forward
r = 12%/yr, c.s.a.
0
$1,000
10
12
14
16
18
20
$1,500
$3,000
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Compound Forward
r = 12%/yr, c.s.a.
0
$1,000
10
$1,500
$3,000
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F7 = ??
Consider:
0
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$150
$75
$100
$45
10
11
12
$50
$200
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CP-2
2
$150
$45
CP-3
$75
$100
CP-4
9
10
11
12
$50
$200
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$150
$200
$45
12
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Revised CF Diagram
$90
5
$75
$150
$200 $200
6
$100
$90
$45
10
11
12
$50
$50
$175
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Revised CF Diagram
$90
10
11
12
$50
$150
$200
$175
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Chapter Summary
Many applications use and apply nominal
and effective compounding
Given a nominal rate must get the interest
rate to match the frequency of the
payments.
Apply the effective interest rate per payment
period.
When comparing varying interest rates, must
calculate the Effective i in order to
compare.
CE 533 Economic Decision Analysis
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Chapter III
End of the Chapter III