n Learning and Teaching Mathematics - Effective interest rates : making sense or cents?

Volume 2015, Issue 18
  • ISSN : 1990-6811


An effective interest rate enables us to compare different interest rates over different periods, and with different compounding frequencies. Consequently, an understanding of effective rates is important for personal finance. In the SA school curriculum, effective interest rates are introduced in Grade 11 in both Mathematics and Mathematical Literacy. However, text books generally do not extend their discussion to engage with the relationship between effective rates and actual banking products. In this article I explore the notion of effective interest by focusing on its definition, its connection to percentage increase, and the derivation of the effective interest formula. I then discuss the interest rates of notice deposits as advertised by two big South African banks and show how effective rates are used in each case. Through this I show that the effective rate formula used at school is not the formula generally used by banks. Rather, banks quote an 'average effective annual rate' as this enables them to quote seemingly higher effective rates.

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