1.1.1 Interest Rate, Stated annual interest rate (SAR), Effective annual Rate (EAR)

The interest rate is interpreted as the internal rate of return, required rate of return, discount rate or opportunity cost .

Interest Rate = Real risk-free rate + Expected inflation + Risk premium (compensate distinct types of risk.

Stated annual interest rate (SAR)
It does NOT account for the effect of compounding within the year. \

SAR= no. of periods in a year (m) x periodic interest rate (r_p)

Effective annual rate (EAR)
It does take the compounding effect in a year into account
EAR = (1 + r_p)^m – 1

SAR and EAR conversion
SAR = [(1 + EAR)^1/m - 1] x m

Notes:
- Assuming continuous compounding at the stated interest rate, EAR = e^SAR-1