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  • 1.  Effective Interest Rate formula derivation

    Posted 04-02-2020 05:10 AM
    Hello people out there,
    Can someone help me with understanding the effective annual interest rate?
    I am finding it difficult to understand the logic behind why is 365/ loan length in days multiplied with [PR+CF]/[1-CB]

    As per my understanding the formula calculates what is the interest percentage paid for the actual amount we use,hence {[int.rate+Commitment fee]/[1-Compensating balance rate]}
    where int.rate + CF is the payment and 1-CB is the actual amount we will be able to use.
    But then why is it again multiplied with 365/loan length?

    I would be so grateful if i could get an answer for this.

    Regards,
    Sivani Ahilanu


  • 2.  RE: Effective Interest Rate formula derivation
    Best Answer

    Posted 04-03-2020 02:54 PM
      |   view attached
    Hello Sivani,

    For better understanding it would be more helpful if you share the case study numbers which is difficulty for you, so we could discuss how the formula works.
    Anyhow, I have attached (3) different question scenarios with regard to effective interest rate, please review and feed back your comments.

    To make it easier, please try to breakdown the above mentioned formula by replacing each part with related step calculation as mentioned in attached examples.

    I would recommend you to check out this site for any required details and explanations:  Corporate Finance Institute (CFI)

    Wish you best of luck, success, safe & healthy condition

    Regards

    ------------------------------
    Samer Ahmad, FMVA, SCA
    Kuwait
    ------------------------------

    Attachment(s)

    pdf
    Effective Rate of Interest.pdf   90 KB 1 version
    Original Message


  • 3.  RE: Effective Interest Rate formula derivation

    Posted 04-04-2020 11:20 AM
    Thank you so much for responding will definitely look into it.

    ------------------------------
    Sivani Ahilan Annalakshmi
    Student
    Tiruchirappalli
    India
    ------------------------------

    Original Message


  • 4.  RE: Effective Interest Rate formula derivation

    Posted 04-04-2020 11:56 AM
      |   view attached

    I was able to understand and workout the sums in the Pdf, but still confused regarding why is [365/ length of days of the loan] is multiplied with according to the formula I learnt.

    To put my query more clear, I have attached the sum with the formula. 

    Regards,
    Sivani Ahilan Annalakshmi 



    ------------------------------
    Sivani Ahilan Annalakshmi
    Student
    Tiruchirappalli
    India
    ------------------------------

    Original Message


  • 5.  RE: Effective Interest Rate formula derivation

    Posted 04-04-2020 08:18 PM
      |   view attached
    Dear Sivani,

    I understand why you are confused by this reversed concept of what we used to follow in order to calculate the interest per days. This is why I recommended to split off the equation according to the steps you apply to find out the solution. Anyhow, I hope the following demonstration will make it more clear to you.
    By the way, the same concept applies when we calculate the opportunity cost of not taking the cash discount in credit terms of 2/10 net 30 ..etc

    Effective Rate of Interest_2

    Kind regards

    ------------------------------
    Samer Ahmad, FMVA, SCA
    Kuwait
    ------------------------------

    Attachment(s)

    pdf
    Effective Rate of Interest_2.pdf   45 KB 1 version
    Original Message


  • 6.  RE: Effective Interest Rate formula derivation

    Posted 04-06-2020 05:11 AM
    THANK YOU SO MUCH! That just put everything on track! Thank you!

    ------------------------------
    Sivani Ahilan Annalakshmi
    Student
    Tiruchirappalli
    India
    ------------------------------

    Original Message