Type of calculation: Converting a nominal annual rate into the effective annual rate (EAR) once you account for interest that compounds several times a year.
Why they differ: Each compounding period adds interest on top of the interest already earned, so the effective rate ends up a little higher than the nominal rate.
The formula:
EAR = ((1 + r / 100 / m)^m − 1) × 100
Given: nominal rate r = 6%, m = 12 compounding
periods per year
r / 100 / m = 6 / 100 / 12 ≈ 0.005
(1 + 0.005)^12 ≈ 1.061678
EAR = (1.061678 − 1) × 100 ≈ 6.17%
That's 0.17 percentage points above the 6%
nominal rate — the extra you earn from compounding during the year.