1. What Is The Effective Annual Rate?

The Effective Annual Rate (EAR) represents the actual annual interest rate when compounding occurs more than once per year. It provides a true comparison of different investment or loan options with varying compounding periods.

2. How Does The Calculator Work?

The calculator uses the effective annual rate formula:

Where:

• \( r \) — Nominal annual interest rate (as decimal)
• \( n \) — Number of compounding periods per year

Explanation: The formula accounts for the effect of compounding by calculating how interest earns additional interest over multiple periods within a year.

3. Importance Of Effective Rate Calculation

Details: Understanding the effective annual rate is crucial for comparing financial products, making informed investment decisions, and accurately assessing the true cost of borrowing or return on investment.

4. Using The Calculator

Tips: Enter the nominal annual interest rate as a percentage (e.g., 5 for 5%), and the number of compounding periods per year (e.g., 12 for monthly compounding, 4 for quarterly).

5. Frequently Asked Questions (FAQ)

Q1: What's the difference between nominal and effective rate?
A: Nominal rate is the stated annual rate without compounding, while effective rate includes the effect of compounding throughout the year.

Q2: When is effective rate higher than nominal rate?
A: Effective rate is always equal to or higher than nominal rate when compounding occurs more than once per year.

Q3: What are common compounding frequencies?
A: Annual (1), Semi-annual (2), Quarterly (4), Monthly (12), Weekly (52), Daily (365).

Q4: Why is effective rate important for borrowers?
A: It shows the true cost of loans when interest compounds frequently, helping borrowers compare different loan offers accurately.

Q5: How does continuous compounding work?
A: For continuous compounding, use the formula \( e^r - 1 \), where e is Euler's number (approximately 2.71828).