# Effective Yield

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## Definition of 'Effective Yield'

The effective yield, also known as the annual percentage yield (APY), is the interest rate that takes into account the effect of compounding interest. It is a more accurate representation of the return on an investment than the nominal interest rate, which does not account for compounding.

To calculate the effective yield, you need to know the nominal interest rate, the number of compounding periods per year, and the number of years you will be investing. The formula for calculating the effective yield is:

```
Effective Yield = (1 + Nominal Interest Rate / Number of Compounding Periods) ^ Number of Compounding Periods - 1
```

For example, if you invest \$100 at a nominal interest rate of 10%, compounded quarterly, for 1 year, the effective yield will be 10.38%. This is because the interest earned in the first quarter will be 10% of \$100, or \$10. This interest will then be added to the principal amount of \$100, for a total of \$110. In the second quarter, the interest earned will be 10% of \$110, or \$11. This interest will then be added to the principal amount of \$110, for a total of \$121. And so on.

The effective yield is a more accurate representation of the return on an investment than the nominal interest rate because it takes into account the effect of compounding interest. This is important for investors who are looking to maximize their returns.

In addition to the effective yield, there are a number of other factors that investors should consider when making investment decisions. These factors include the risk of the investment, the liquidity of the investment, and the tax implications of the investment. By considering all of these factors, investors can make informed decisions about where to invest their money.

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