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Effective Annual Rate Formula:
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The Equivalent Annual Rate (EAR), also known as Effective Annual Rate, calculates the actual annual interest rate when compounding occurs more frequently than annually. It provides a standardized way to compare different investment or loan options with varying compounding periods.
The calculator uses the EAR formula:
Where:
Explanation: The formula accounts for the effect of compounding by calculating the total interest earned or paid over one year, considering how frequently interest is compounded.
Details: EAR is crucial for comparing financial products with different compounding frequencies. It provides a true measure of the cost of borrowing or the return on investment, allowing for accurate comparisons between options.
Tips: Enter the nominal interest rate as a decimal (e.g., 0.05 for 5%), and the number of compounding periods per year. All values must be valid (nominal rate between 0-1, compounding periods ≥1).
Q1: Why is EAR different from the nominal rate?
A: EAR accounts for compounding effects, while the nominal rate does not. More frequent compounding results in a higher EAR compared to the nominal rate.
Q2: What are common compounding periods?
A: Common periods include: annually (n=1), semi-annually (n=2), quarterly (n=4), monthly (n=12), weekly (n=52), and daily (n=365).
Q3: How does compounding frequency affect EAR?
A: Higher compounding frequencies result in higher EAR values for the same nominal rate, due to more frequent interest calculations.
Q4: When is EAR used in financial decisions?
A: EAR is used when comparing loans, credit cards, savings accounts, investments, and any financial products with different compounding periods.
Q5: What is the difference between APR and EAR?
A: APR (Annual Percentage Rate) typically refers to the nominal rate, while EAR represents the actual annual rate including compounding effects.