What are the applications of nominal interest rates?

The term "nominal interest rate" is generally used in one of two ways: to describe the return on investment or the amount of interest charged from the loan. This can be considered as a cited interest rate. If the bank states that it charges 6 % interest out of a 15 -year mortgage, the nominal interest rate is 6 percent. Similarly, the nominal rate for the savings account is additional interest, which provides as a percentage of the total stored. Nominal interest rates are not modified about inflation. For example, if someone makes an initial amount of $ 1,000 in USD (USD), which earns 10 percent of annual interest, it will receive $ 100. The interest payment is added to the initial deposit, which increases the account balance to $ 1,100. In the second year, the investor continues to receive 10 % interest on the new balance, resulting in additional interest rates of $ 110, and the total number of $ 1,2110.

problem using nominal interest rates for calculating earningsIt is that inflation does not take into account. Assuming the inflation rate of 5 percent, the actual income in the above example would reduce to $ 50 in the first year and $ 52.50 in the second year. Because inflation reduces the expenditure power of money, the value of $ 1 decreases over time. Getting the same types of goods requires more money and therefore can be relying on the nominal interest rate misleading.

If, for some unlikely reason, inflation remains at zero, nominal interest rates would be the correct estimate of earnings. One of the reasons why some investors risk greater risks in the stock market is to get a high nominal interest rate. This high rate helps to compensate for inflation costs in the long run. For example, a stock portfolio that provides an average yield of 15 Zations for 30 years is considered normal or adequate.

Nominal rates also reflect loan costs. If the consumer takes a car loan for $ 10,000 and pays the first year $ 500 in interestPayments, nominal rates are 5 percent. The creditor takes over the risk that the inflationary exceeds the interest rate as well as the risk of payment failure. In the United States, nominal interest rates may affect the cost of lending from the federal reserve system, the macroeconomic conditions and the credit history of the individual.