Hi,

After talking with a student I figured that the quick overview I had on Monday might caused a little confusion regarding effective interest, effective interest rate and simple interest (it even confused me for a couple of minutes). So inorder to avoid further confusion, here is a summary of what you should know, hopefully it will help.

**Kinds of Interest Rates**

There are 3 kinds of interest rates:

- j – effective interest rate
- i – nominal interest rate
- r – real interest rate

**Kinds of Interest Programs**

There are 4 kinds of interest programs:

- Simple interest: FV=PV*(1+jt)
- Effective interest: FV=PV*(1+j)^t
- Compounded Interest: FV=PV*(1+i/n)^nt
- Continuously Compounded Interest: FV=PV*e^rt

We noted that effective interest is the same as compounded interest when it is compounded yearly, however (and here begins the confusing part) it is computed using the **effective** interest rate. Now, the simple interest plan **also** uses the effective interest rate (which is the second cause for confusion) **but** it is compounded **once in the whole loan period** and not yearly.