From the course: Fixed Income Fundamentals

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Nominal, effective, and real yield

Nominal, effective, and real yield

From the course: Fixed Income Fundamentals

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Nominal, effective, and real yield

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- [Instructor] On this slide, we do a quick refresher of nominal and effective rates that we covered in detail in the Financial Maths course. Most interest is calculated on a compound basis, meaning that interest is earned on accrued interest. The effective rate of interest describes how much interest would be earned if that interest was compounded once per period. For example, if we have a simple 5% nominal rate, $100 in one year's time becomes $105, that gives us an effective yield of 5%. However, the same 5% nominal rate compounded semi-annually would give us, $100 in six months becomes 102.50 because you get that half coupon payment and in one year's time, the total amount that you'll have is $105, 0.0625 cents. So your effective yield is actually slightly higher at 5.0625%. This is an important theme to grasp as bond coupons are generally paid semi-annually. So if this concept is still unclear to you, I would recommend you go back to the Financials Maths course for further…

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