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ISE2014_Class10

# ISE2014_Class10 - Class 10 Effective Interest ISE 2014...

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Click to edit Master subtitle style Class 10 – Effective Interest ISE 2014 Fall 2010

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Effective Interest Rates Remember our formula for calculating an effective interest rate In both of our homework problems, M = N Some of you have been asking to work a problem where M ≠ N Let’s work one of those as a refresher before jumping into credit cards
Effective Interest Rates Lets say we’re going to make semi-annual deposits of \$5,000 into a bank account for 10 years The bank account has a nominal annual interest rate of 7%, compounded monthly At the end of 10 years you want to know how much is in the account

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Effective Interest Rates First of all, do why do we need an effective interest rate? Semi-annual cash flows with monthly compounding… this isn’t compatible Lets setup a cash flow diagram with our tic marks representing half years
Effective Interest Rates We have 20 half-years, with a \$5,000 deposit on each year If we were to find an effective semi-annual interest rate, we could use our tool/equation for an annuity We cannot just use the monthly interest rate, because then there would only be a payment every 6th month

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Effective Interest Rates Lets apply our formula to find an effective semi-annual interest rate: isemi-annual = (1 + .07/12)6 – 1 isemi-annual = .0355 or 3.55% Now let’s get our answer: X20 = \$5,000(F/A,3.55%,20) We don’t have a table for 3.55%, so we need to use formula
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ISE2014_Class10 - Class 10 Effective Interest ISE 2014...

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