Nominal rate
Stated interest rate without accounting for compounding frequency or inflation.
The nominal rate is the annualized interest rate as contractually stipulated, without accounting for compounding frequency. A 6% nominal rate compounded monthly does not equate to 6% effective per year: the monthly rate is 6%/12 = 0.5% and the effective annual rate is (1 + 0.005)^12 − 1 ≈ 6.17%. The distinction between nominal and effective rates is fundamental in finance and actuarial science. In insurance, the nominal rate is used to set credited rates on reserves (euro funds in life insurance, annuities), while the effective rate measures true annualized return. Continuous compounding is the limit as compounding frequency tends to infinity. The nominal rate also stands against the real rate, which strips out inflation: an investment at 3% nominal over a year of 2% inflation returns about 1% in purchasing power.
Textbook case: a savings account at a 3% nominal rate, compounded monthly. Effective annual rate = (1 + 0.03/12)^12 − 1 ≈ 3.04%. The gap looks small, but it adds up over 20 years.
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