Documentation/How Tos/Calc: EFFECTIVE function

EFFECTIVE

Returns the effective compounded interest rate given a nominal interest rate.

Syntax:

EFFECTIVE(nom_rate; num)

nom_rate: the nominal interest rate.

num: the number of times interest is credited / compounded during the period that nom_rate applies to.

If an investment has a nominal rate, say for a year, but interest is paid and credited say each quarter, the interest paid each quarter will itself start earning interest. This increases the effective value. This function returns the effective rate - that is, the rate that would have to be paid at the end of the (say) year to give the same return.

The formula used is:

effective_rate = (1 + nom_rate/num)^num - 1

Example:

EFFECTIVE(6%; 4)

returns approximately 6.14%, which is the effective rate of an investment with a nominal rate of 6% per annum, compounded quarterly.

Issues:

• According to the draft ODFF standard, this function will be replaced with a new EFFECT function.
• The calculation assumes that interest is credited at the end of exactly equal periods. In reality different quarter-years, for example, have different numbers of days.