The interest rate that results from converting the stated annual interest rate to a rate associated with a partial period. The rate per period is usually calculated using this formula:
Periodic rate = stated annual rate / number of interest payments per year
For example, if the stated annual interest rate is 6% on a bond that pays coupon semi-annually, then:
Period rate = 6% / 2 = 3%
This rate is the one used to calculate periodic interest payments and also to determine the effective annual rate. For example, in semi-annual compounding, the effective annual rate will depend on compounding the period rate for two times”
Effective annual rate = (1+ ½ periodic rate)2 – 1 = (1 + 3%)2 -1 = 6.09%
Therefore, compounding the period rate results in an effective interest rate larger than the stated rate.
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