See Also:
What is Compound Interest
Effective Rate of Interest Calculation
Interest Expense
When is Interest Rate Not as Important in Selecting a Loan?
Interest Rate SwapsNominal Interest Rate DefinitionA nominal interest rate is the
interest rate rate quoted on lending and borrowing transactions. Nominal rates represent the rate of exchange between current and future dollars, unadjusted for the effects of
inflation. Since nominal rates are not adjusted for inflation, they do not convey the prices of lending and borrowing transactions as accurately as real interest rates, which are adjusted for inflation.
Nominal Interest Rate, Real Interest RateNominal interest rates are not adjusted for inflation. Real interest rates are adjusted for inflation. The adjustment can be made with current or projected inflation rates. Real interest rates offer a more accurate representation of the prices of lending and borrowing transactions. Real interest rates are calculated as follows:
Real Interest Rate = Nominal Interest Rate – Inflation RateFor example, if a lender offers a loan with a nominal rate of 5% and the inflation rate is 3%, then the lender will earn real interest of 2%. If, however, the inflation rate is 7%, then the lender will essentially be losing value on the
loan.