Basics of the yield calculation
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Preface
The question how expensive a credit or how high the effective interest on a deposit is often has no clear answer.
There is nominal interest, effective interest and additional expenses that help confuse the consumer. And that is
not amazing, because your money is big buisness.
So let me try to explain the circumstances as simply as possible.
1.) effective interest = yield = internal rate of return
When you borrow money from somebody you will pay interest. This interest will be the yield for your credit giver.
So the math is the same; only the terms are depending on the side where you are standing.
And in both cases, you calculate the internal rate of return. Stop - you may think - and what about all the interest
formulas, which one learned sometimes ago? If everthing is that easy, why do we have them?
The answer: the IRR-formula is not easy to calculate - if you don´t have a computer. In former days you where happy
to have "simple" and solvable formulas for the calculation of the yield.
2.) nominal interest is for financial mathematicians
You as a consumer are not interested in this.
3.) effective interest should contain every payment
Every payment that is associated with the deal should be included. And there are many. Examples: account
processing, supply interest, estimate fees, partial disbursement impacts, insurance premiums,
administrative expense lump sums, conclusion fees etc..
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Encyclopedia
Analysis - Internal Rate of Return (IRR)
Internal rate of return (IRR)
Return on Investment (ROI)
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