An automobile financier claims to be lending money at simple interest, but he includes the interest every six months for calculating the principal. If he is charging an interest of 10%, the effective rate of interest becomes:

Concept: The financier says simple interest but adds interest to principal every six months → effectively compound interest (half-yearly).

Given: Nominal rate = 10% p.a. ⇒ 5% per half-year.

Effective annual rate(1 + 0.05)^2 − 1 = 1.1025 − 1 = 0.1025 = 10.25%

Thus, the effective rate of interest is 10.25%.