1. What is Effective Annual Rate?

The Effective Annual Rate (EAR) represents the actual annual interest rate when compounding occurs more than once per year. It provides a true comparison of different investment or loan options with varying compounding frequencies.

2. How Does the Calculator Work?

The calculator uses the EAR formula:

Where:

• \( r \) — Nominal annual interest rate (as decimal)
• \( n \) — Number of compounding periods per year

Explanation: The formula accounts for the effect of compounding, showing how more frequent compounding increases the effective return.

3. Importance of EAR Calculation

Details: EAR allows for accurate comparison between financial products with different compounding frequencies. It helps investors and borrowers understand the true cost or return of financial instruments.

4. Using the Calculator

Tips: Enter the nominal annual interest rate as a percentage and the number of compounding periods per year. Common compounding frequencies include monthly (12), quarterly (4), semi-annually (2), and daily (365).

5. Frequently Asked Questions (FAQ)

Q1: What's the difference between nominal rate and EAR?
A: Nominal rate doesn't account for compounding frequency, while EAR shows the actual annual rate including compounding effects.

Q2: When is EAR higher than nominal rate?
A: EAR is always equal to or higher than the nominal rate when compounding occurs more than once per year.

Q3: What is continuous compounding?
A: Continuous compounding uses the formula \( EAR = e^r - 1 \), where compounding occurs infinitely often.

Q4: How does compounding frequency affect EAR?
A: Higher compounding frequency results in higher EAR for the same nominal rate.

Q5: Is EAR the same as APY?
A: Yes, EAR is equivalent to Annual Percentage Yield (APY) in banking contexts.