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Effective Interest Rate

Definition of "Effective interest rate"

Patty Radford
  Radford Realty Group

Real rate of interest on a loan. It is the coupon rate divided by the net proceeds of the loan. Assume Sharon
took out a $1,000,000, on year, 10% discounted loan to buy real estate. The effective interest rate equals:
in this discount loan the proceeds received is only $900,000, which effectively increases the cost of the loan.
The effective annual yield, also called the annual percentage yield (APY). Different kinds of investments have different compounding periods.
For example, some banks pay interest quarterly. If an investor wants to compare investments with different compounding periods, she must place them on a common basis. It is used for this purpose
and is computed as follows.

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