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Following our earlier example, if your dividend rate at a credit union is 4.5% and interest is compounded monthly, your APY would be 4.59% for the same account.
This is a reasonable approximation if the compounding is daily. Also, a nominal interest rate and its corresponding APY are very nearly equal when they are small. For example (fixing some large N), a nominal interest rate of 100% would have an APY of approximately 171%, whereas 5% corresponds to 5.12%, and 1% corresponds to 1.005%.
The terms "APY" and "interest rate" are often used interchangeably when people discuss savings and investments, but there's a very important distinction between the two. While it's important to...
A 5.00% APY means that your account will yield an interest rate of 5% after one year. For example, if you deposited $1,000 in an account with a 5.00% APY, you would earn $50 in interest.
The nominal interest rate, also known as an annual percentage rate or APR, is the periodic interest rate multiplied by the number of periods per year. For example, a nominal annual interest rate of 12% based on monthly compounding means a 1% interest rate per month (compounded). [2]
In the case where the growing quantity is a financial asset, is a nominal interest rate and is the corresponding real interest rate; the first-order approximation = is known as the Fisher equation. [1]