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2504c_0927 - BUSI 2504c Essentials of Business Finance...

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BUSI 2504c - Essentials of Business Finance Monday, September 27, 2010 18:15-18:45 Quiz #1 §6.3 effective annual rate (EAR) annual percentage rate (APR) §6.4 loan types and amortization
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chapter 6 (cont.): (EAR) & (APR) §6.3 - effective annual rate (EAR) & annual percentage rate (APR) §6.4 - loan types and amortization BUSI 2504c Monday, September 27, 2010 2 / 22
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6.3: effective annual rate (EAR) This is the actual rate paid (or received) after accounting for compounding that occurs during the year If you want to compare two alternative investments with different compounding periods, you need to compute the EAR for both investments and then compare the EAR’s. BUSI 2504c Monday, September 27, 2010 3 / 22
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6.3: annual percentage rate (APR) This is the annual rate that is quoted by law By definition APR = period rate times the number of periods per year Consequently, to get the period rate we rearrange the APR equation: Period rate = APR / number of periods per year You should NEVER divide the effective rate by the number of periods per year - it will NOT give you the period rate BUSI 2504c Monday, September 27, 2010 4 / 22
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6.3: EAR and APR For example, suppose a bank offers a rate to depositors of 8% per year. The nominal or annualized rate (APR) is, therefore, 8%. If the bank compounds interest once per year, then the effective rate (EAR) is identical to the nominal rate (APR), namely, 8%. If the bank compounds more than once per year, then effectively, depositors will end up with more than an 8% return at the end of the year. If compounding is semiannual, 4% every 6 months - 8.16% If compounding is quarterly, 2% every 3 months - 8.2432% If compounding is monthly, .667% every month -8.29995% If compounding is daily, .022% every day - 8.3278% BUSI 2504c Monday, September 27, 2010 5 / 22
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6.3: EAR and compounding frequency $225.00 H EAR 50.00 % L annual compounding $244.14 H EAR 56.25 % L semi - annual compounding $256.58 H EAR 60.18 % L quarterly compounding $266.37 H EAR 63.21
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