Final answer:
The nominal rate of interest is used to calculate compound interest over time but does not take into account factors like inflation and taxes, which can affect the real value of interest earnings.
Step-by-step explanation:
When calculating the nominal rate of interest, it is essential to understand the principle of compounding over a period of time. For example, if you deposit $100 in a bank account with a 2% annual interest rate, after one year you would have $102, after the second year $104.04, and so on, following the formula for the future value that is the present value multiplied by (1 + Interest rate)number of years t. However, nominal rates can become less attractive when inflation and taxes come into play. If you earn 5% interest, or $500 on a $10,000 investment, you will owe tax on this amount regardless of the inflation rate. If inflation is 10%, your real rate of interest is -5%, meaning you lose buying power but still owe tax on the nominal gains.