1. What is Effective Annual Rate?

The Effective Annual Rate (EAR) is the actual annual interest rate that accounts for compounding effects. It represents the true cost of borrowing or the true return on investment when compounding is considered.

2. How Does the Calculator Work?

The calculator uses the Effective Annual Rate formula:

Where:

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

Explanation: The formula calculates the actual annual return by considering how many times the interest is compounded within a year.

3. Importance of EAR Calculation

Details: EAR provides a standardized way to compare different financial products with varying compounding frequencies. It helps investors and borrowers understand the true cost or return of financial instruments.

4. Using the Calculator

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

5. Frequently Asked Questions (FAQ)

Q1: What's the difference between nominal and effective rate?
A: Nominal rate doesn't account for compounding, while effective rate shows the actual annual return including compounding effects.

Q2: How does compounding frequency affect EAR?
A: Higher compounding frequencies result in higher effective rates. For example, monthly compounding yields a higher EAR than annual compounding at the same nominal rate.

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

Q4: When is EAR most important?
A: When comparing loans, savings accounts, or investments with different compounding frequencies and nominal rates.

Q5: Can EAR be lower than nominal rate?
A: No, EAR is always equal to or greater than the nominal rate due to compounding effects.