Distinction Between Nominal and Effective Interest Rate

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Distinction between nominal and effective interest rate Nominal interest rate does not compound (added to the principal amount). The interest rate stated on an investment agreement or loan document is the interest paid to the new bondholder. There is also no adjustment for inflation, and if the interest is not paid, it is added to the principal balance. The effective interest rate is compounding (added to the principal) each period it is paid. Interest is calculated on the new principal amount. Each interest period bring in a little more interest income. Difference between face value and market value Face value, also known as par value, is the amount paid to a bondholder at the maturity date. Before maturity, depending on the interest rate payable and the perceived risk of default, a bond’s value may be greater or less than face value. As an example; a 10-year bond with a face value of $1,000 and an 8% interest rate will pay the bondholder $80 a year for 10 years. The bondholder will receive the $1,000 principal when the bond matures. Market value is the current quoted price at which buyers and sellers reach agreement in secondary markets (stock-exchange and debt-purchase agreements). The market value of an investment can deviate considerably from its face value. It does not mean that the investors get a better yield than the market is offering, it is just sold at a price below par. The quote of a bond prices is the percent of bond face value. A price of 97-1/2 means that the bond is selling for 97-1/2 % of its face value of $1,000 and the bond discount rate is 2-1/2%. When a bond sells for a higher price than its stated value, it is selling at a premium. If a bond is selling at 102, it is selling at 2% premium. This happens when a bond is in high demand. Significance of the market value increase to the company On the company’s fiscal closing

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