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**Unformatted text preview: **1 TIME VALUE OF MONEY ANNUAL (NOMINAL) & EFFECTIVE INTEREST RATES 2 Annual Percentage Rate (“APR”) ❚ The annual rate that is quoted by law ❚ Often referred to as the “NOMINAL RATE” ❚ APR = period rate X # of periods per year ❚ Period rate = APR / # of periods per year 3 Computing APRs (Q) ❚ What is the APR if the monthly rate is .5%? ❚ What is the APR if the semiannual rate is 2.0%? ❚ What is the monthly rate if the APR is 12% with monthly compounding? 4 Computing APRs (A) ❚ What is the APR if the monthly rate is .5%? ❚ 0.5(12) = 6% ❚ What is the APR if the semiannual rate is 2.0%? ❚ 2.0(2) = 4% ❚ What is the monthly rate if the APR is 12% with monthly compounding? ❚ 12 / 12 = 1% 5 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. 6 APRs & EARs (Q -1) ❚ Suppose you can earn 1% per month on $1 invested today....

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