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Unformatted text preview: T HE EFFECT OF COMPOUNDING PERIODS When you see interest rates quoted you may see them in several different forms. How rates are quoted is often the result of tradition or legislation . Or, unfortunately, they may be the result of an effort to deceive investors or borrowers. Effective Annual Interest Rate (EARs) and Compounding If a loan that compounds annually, the same as a loan that compounds semiannually? If you understand what we have done in the time value of money, you will realize intuitively that it is not. For example, if you invest $100 for 1 year at 10% interest that is compounded annual, you have $110 at the end of 1 year. On the other hand, if you invest $100 for 1 year at 10% with semiannual compounding, you will have: 100(1+.10/2) 2 or, you will have $110.25. The additional $.25 arises as a result of the interest that you earn on the $5 interest The additional $....
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