Which one of the following best defines a nominal interest rate?

• A. The rate of return required by investors after taxes.
• B. The interest rate adjusted for inflation.
• C. The effective annual interest rate that includes the effects of compounding.
• D. The stated annual interest rate that does not account for compounding within the year.

Answer: (D)

Verified step by step guidance

1. Understand the concept of nominal interest rate: It is the stated annual interest rate that does not account for compounding within the year. This means it is the rate explicitly mentioned in financial agreements or advertisements, without adjustments for inflation or compounding effects.
2. Differentiate nominal interest rate from other types of interest rates: For example, the effective annual interest rate includes compounding effects, while the real interest rate adjusts for inflation.
3. Recognize that nominal interest rates are often used in financial contracts and are the basis for calculating periodic interest payments, but they do not reflect the true cost of borrowing or the true return on investment.
4. Consider practical applications: Nominal interest rates are commonly used in loan agreements, bond yields, and savings accounts. They are important for understanding the basic terms of financial products.
5. Review the options provided in the problem and identify the correct definition: The nominal interest rate is best defined as 'The stated annual interest rate that does not account for compounding within the year.'