Financial models are often driven by percentages in one way or another.
Two common ones are the inflation rate and interest rates on debt. When you get an input for one of these it is important to understand whether the percentage given is a nominal or effective rate. In models that stretch of many years, this can have a material effect on the results.
As an example, say you borrow $100 at an effective 12% compounded monthly. If you treat this effective rate as a nominal rate you will calculate that at the end of the year you will receive $112.68. In reality though you will only get $112.
The effective rate is the amount you will get no matter what compounding method is used i.e. if you put $100 in the bank and get 12% EFFECTIVE compounded monthly you will get $112 at year end.
However, if you do the detailed calculation and assume 1% per month you get a different number as shown below.
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