Financial Dictionary

Annual percentage yield (APY) can be seen as an accounts true interest rate. It is the percentage that indicates the true return of an interest rate over the course of a year when the benefits of compounding are considered. Most financial institutions that want their nominal interest rates to look higher will state the annual percentage yield for their account rather than the nominal interest rate, or Annual Percentage Rate (APR).

There is a rather straight forward equation used to calculate the annual percentage yield for an account. The equation is seen below:

The variables in this equation represent the corresponding ideas:

inom - this is the nominal interest rate for your account.

N - this is the number of compounding periods in a given year

The number that changes the most in this equation is the nominal interest rate. Banks decide what this rate will be and it often fluctuates depending on what the Federal Reserve has done with interest rates recently. Generally speaking, the lower the Federal Reserve has lowered interest rates the lower the nominal interest rate is going to be on your account.

The compounding period, however, is generally very stable. In most circumstances the compounding period will be daily, but interest will only be credited monthly.

Accounts That Use APY

• Savings Accounts
• Certificates of Deposit
• Checking Accounts
• Money Market Accounts