What is nominal?
Nominal is a common financial term with several different contexts. In the first, it means very small or well below the actual value or cost. In finance, this adjective modifies words such as fees or charges. Nominal fees are lower than the price of the service provided or likely easy to pay for a consumer, or fees sufficiently modest to have no significant impact on his finances.
In finance and economics, the nominal can also denote an unadjusted rate or the change in value. When you define things like gross domestic product (GDP) or interest rates, the face value indicates an uncorrected figure for seasonality, inflation, interest composition, and other modifiers. In this use, the nominal shows the contrast with the “real” economic statistics which make such adjustments or modifications to the results.
Since a nominal figure will deal with the unadjusted value of a study, it is preferable not to use it as a comparative figure. Consider someone who has $ 100 in 1950 versus someone with $ 100 in 2020. Although the two people have $ 100 – the face value – the actual value is not the same because it ignores the ‘inflation.
The nominal value of an asset can also mean its nominal value. For example, a bond with a face value of $ 1,000 has a face value of $ 1,000.
Nominal vs real
The actual term, as opposed to nominal, expresses the value of something after adjusting various factors to create a more precise measure. For example, the difference between nominal GDP and real GDP is that nominal GDP measures a country’s economic output using current market prices, and real GDP takes inflation into account to create a more accurate measure .
Key points to remember
- Nominal is a financial term that has several different contexts.
- This can mean small or much less than the actual value or cost, such as a nominal fee.
- The nominal also refers to an unadjusted value rate such as interest rates or GDP.
Nominal vs real rate of return
The rate of return (RoR) is the amount that an investor earns on an investment. While the nominal rate of return reflects the investor’s income as a percentage of the initial investment, the real rate takes inflation into account. Consequently, the real rate gives a more precise assessment of the real purchasing power of the investor’s income.
For example, imagine that you buy a stock for $ 10,000 and sell it the following year for $ 11,000. Your nominal rate of return is 10%. However, to get a more accurate picture of your actual return, this rate needs to be adjusted for inflation, as the purchasing power of your money likely changed during the year. Therefore, if inflation for this year is 4%, the real rate of return is only 6% or the nominal rate of return minus the rate of inflation.
Nominal and real interest rates
Like the difference between nominal and real rates of return, the difference between nominal and real interest rates is that the latter are adjusted for inflation. However, in terms of interest, the nominal rate also contrasts with the annual percentage rate (APR) and the annual percentage return (APY). In the case of the APY, the nominal or declared rate is the rate announced by the lender and it is the basic interest rate that the consumer pays on the loan.
On the other hand, APR takes into account the fees and other costs associated with the loan and calculates the interest rate taking into account these factors. For example, imagine that a borrower takes out a loan of $ 1,000 with a nominal interest rate of 5%, but also pays an origination fee of $ 100. During the first year of the loan, he faces $ 50 in interest charges. However, when we factor in the set-up costs, it pays $ 150 in fees and interest. This total amount of fees is equivalent to a APR of 15%. Conversely, APY takes into account both the costs and the effect of the composition to give the borrower an even more precise picture of his interest rate.
Example from the real world
According to ING, there were some upside risks to the consumer price index (CPI) when the Bank of Russia decided to keep the key rate at 7.75%, which slightly improved the outlook for the YE19 CPI at about 5.0%. One of the upside risks was the “Slowing growth in household savings in RUB to 5-7% yoy in terms of accelerating growth in personal loans to 23% yoy indicates pressure on the savings rate. “