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FIN 3100 Exam #2 - Chapter 5 Interest rates It could be...

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Chapter 5 – Interest rates It could be compounded daily, weekly, monthly, quarterly, or semi-annually. r and the t must match 10% compounded semi-annually is 10% / 2 = 5% paid every six months. o $1,000(1.1) = $1,100.00 Annually o $1,000(1.05) 2 = $1,102.50 → 10.25% [($1,102.50-$1,000) / $1,000] Semiannually o 10% is the stated (quoted) rate and 10.25% is the effective annual rate (EAR). To be comparable, rates must be converted to effective rates . The relationship between a quoted rate, such as an annual percentage rate (APR), and the effective annual rate (EAR) is: o . o Where m is the number of times during the year the money is compounded (the number of payments during the year). Examples: 1. 15.5% compounded quarterly? a. EAR = [1 + (.155/4)]4 – 1 = 16.42% 2. 15% compounded daily? a. EAR = [1 + (.15/365)]365 – 1 = 16.18% Which quoted rate is better depends on if you are borrowing or lending The more frequent the payment, the lower the annual amount paid. You should choose the loan with the lowest EAR Real Rates are the increase in purchasing power. Inflation Rate measures the growth in average prices. It is what we expect . Nominal Rate is the rate we observe in the market. Expected Inflation Real Nominal rate The real rate rewards you for deferring consumption.
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