1. What is Effective Annual Rate?

The Effective Annual Rate (EAR) is the actual interest rate an investor earns or pays in a year after accounting for compounding. It provides a true comparison of different financial products with varying compounding periods.

2. How Does the Calculator Work?

The calculator uses the EAR formula:

Where:

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

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

3. Importance of EAR Calculation

Details: EAR is crucial for comparing different financial products like loans, savings accounts, and investments. It helps consumers make informed decisions by showing the true cost or return of financial products.

4. Using the Calculator

Tips: Enter the nominal annual interest rate as a percentage and the number of compounding periods per year. Common compounding frequencies include: 1 (annual), 2 (semi-annual), 4 (quarterly), 12 (monthly), 365 (daily).

5. Frequently Asked Questions (FAQ)

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

Q2: Why is EAR higher than nominal rate?
A: EAR increases with more frequent compounding because interest earns interest more often.

Q3: What is continuous compounding?
A: When compounding occurs infinitely often, EAR = e^r - 1, where e is Euler's number (approximately 2.71828).

Q4: How does compounding frequency affect EAR?
A: Higher compounding frequency results in higher EAR for the same nominal rate.

Q5: When is EAR most important?
A: When comparing loans, credit cards, savings accounts, or investments with different compounding periods.