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Annual Equivalent Rate Formula:
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The Annual Equivalent Rate (AER) is the effective annual interest rate that accounts for compounding effects. It shows the true annual return on an investment or the true annual cost of a loan, considering how often interest is compounded throughout the year.
The calculator uses the AER formula:
Where:
Explanation: The formula calculates the effective annual rate by considering how compounding frequency affects the overall return. More frequent compounding results in a higher AER compared to the nominal rate.
Details: AER provides a standardized way to compare different financial products with varying compounding frequencies. It helps investors and borrowers understand the true annual cost or return, making it easier to compare offers from different financial institutions.
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, 4 for quarterly, 1 for annual). All values must be valid (nominal rate ≥ 0, compounding periods ≥ 1).
Q1: What's the difference between nominal rate and AER?
A: The nominal rate doesn't account for compounding frequency, while AER shows the actual annual return including compounding effects.
Q2: When is AER higher than the nominal rate?
A: AER is always equal to or higher than the nominal rate. It equals the nominal rate only when compounding occurs annually (n=1).
Q3: How does compounding frequency affect AER?
A: More frequent compounding (higher n) results in a higher AER, as interest is calculated on previously earned interest more often.
Q4: Is AER the same as APY?
A: Yes, AER is essentially the same as Annual Percentage Yield (APY) used in some countries. Both represent the effective annual rate including compounding.
Q5: Where is AER commonly used?
A: AER is widely used for savings accounts, certificates of deposit, loans, and any financial product where compounding occurs more frequently than annually.