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Unformatted text preview: can solve for the Effective Annual Rate (EAR) that would give the investor the same return. Bank A: rYr = 12% – After one year: you have – $1*(1+rYr)=$1(1+0.12) = $1.12 = $1(1+rYr) – So we found that rYr = rYr= EAR (to state the obvious) If interest is compounded once per year, the stated rate is the EAR. Example: What is the effective annual interest rate (EAR) that yields the same return as Bank C s offer of 3% compounded quarterly? a) 12% b) 12.36% c) 12.48% d) 12.55% e) None of the above Correct answer is d) How Interest Rates are Annualized  Interest rates are normally quoted on an annual basis.  So how should one annualize interest rates that are compounded more than once per year? – One could calculate the corresponding effective annual rate (EAR) as we did above or – One could just multiply the effective periodic rate by the number of compounding periods per year.  For a variety of reasons, including tradition, government legislation, and attempts to mislead borrowers, these rates are typically annualized by multiplying them by the number of compounding periods per year.  These artificially created annual rates are called nominal rates, or quoted rates, or stated rates.  This is how Annual Percentage Rates (APRs) are calculated (by law) – Said differently, APRs are nominal rates! – We usually call them nominal interest rates compounded m 12 times per year, or im. (note: book uses ‘q’ instead of ‘i’)...
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This document was uploaded on 03/17/2014 for the course COMM 298 at University of British Columbia.
 Spring '14

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