Final answer:
Effective interest rate is not the conventional method of stating the annual interest rate; it refers to the rate after compounding, unlike the nominal rate which is conventionally used. Real interest rate takes inflation into account, altering the cost of borrowing.
Step-by-step explanation:
The statement "Effective interest rate is the conventional method of stating the annual interest rate" is False.
The effective interest rate typically refers to the annual interest rate after the effect of compounding, whereas the nominal interest rate or the stated interest rate is the conventional method of stating the annual interest rate without taking compounding into consideration.
Real interest rate is calculated by adjusting the nominal interest rate for the effects of inflation.
For example, if the nominal interest rate is 7% and the rate of inflation is 3%, the real interest rate effectively would be 4%, which is the cost of borrowing after the inflation adjustment.
However, if there is deflation of 2%, the real interest rate would be 9%, increasing the cost for borrowers and potentially leading to economic challenges.
Simple interest is another concept where interest is calculated only on the principal amount, without compounding.
Unlike effective interest rate, simple interest does not take into account the effect of compounding.
Financial instruments like bonds might specify whether they use simple interest or compound interest in their contract terms.