What distinguishes a nominal interest rate from an effective interest rate?

The distinction between nominal interest rates and effective interest rates is crucial in understanding how interest calculations work, especially when considering loans and investments. The nominal interest rate is essentially the stated rate without taking into account the effect of compounding within the year. On the other hand, the effective interest rate reflects the true cost or yield of the investment or loan once all compounding periods are considered.

For instance, if a nominal interest rate is quoted as 6% per annum, but the interest is compounded semi-annually, the effective interest rate would be higher than 6% due to that compounding effect, which captures the additional earnings on interest that has already been added to the principal. This makes option C correct, as it accurately describes that the nominal rate is the stated rate, while the effective rate accounts for the actual payments made, incorporating the impacts of compounding throughout the year.

Other options do not accurately characterize the relationship between the two rates. For instance, the distinction regarding taxes or fees does not define nominal and effective rates, as both types can be analyzed without directly referencing these factors.