Periodic Interest Rate
For example, the interest on a mortgage is calculated monthly. If the annual interest rate is 8%, the periodic interest rate used to calculate the interest charge due in any single month would be 0.08 / 12 = .00666 or 0.666%.
Keep in mind that the more frequently an investment compounds, the more quickly the principal grows. For example, let's say two options are available on an investment of $1,000.
Option 1 - Invest $1,000 at 8% compounded monthly.
Option 2 - Invest $1,000 at 8.125% compounded annually.
At the end of 10 years, Option 1 grows to $2,219.64. Option 2 grows to $2,184.04. Even though the interest rate on Option 2 is higher by 0.125%, the more frequent compounding of Option 1 (caused by the earning of interest on interest) yields a higher end amount.
Investment dictionary. Academic. 2012.
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