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Effective Annual Rate Formula:
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The Effective Annual Rate (EAR) represents the actual annual interest rate when compounding occurs more than once per year. It accounts for the effect of compounding periods and provides a true comparison of different financial products.
The calculator uses the EAR formula:
Where:
Explanation: The formula calculates the actual annual return by considering how many times interest is compounded within a year, providing a more accurate measure than the nominal rate.
Details: EAR is crucial for comparing different financial products with varying compounding frequencies. It helps investors and borrowers understand the true cost or return of financial instruments, enabling better financial decision-making.
Tips: Enter the nominal rate as a decimal (e.g., 0.05 for 5%), and the number of compounding periods per year (e.g., 12 for monthly compounding). All values must be valid (nominal rate between 0-1, compounding periods ≥1).
Q1: What's the difference between nominal rate and EAR?
A: Nominal rate doesn't account for compounding frequency, while EAR reflects the actual annual return including compounding effects.
Q2: How does compounding frequency affect EAR?
A: Higher compounding frequency results in higher EAR for the same nominal rate, as interest is calculated more frequently.
Q3: When is EAR most useful?
A: When comparing loans, investments, or savings accounts with different compounding periods to determine the best option.
Q4: Can EAR be converted back to nominal rate?
A: Yes, with known compounding frequency, but the calculation is more complex and requires solving the EAR formula for r.
Q5: What are typical compounding frequencies?
A: Common frequencies include annual (1), semi-annual (2), quarterly (4), monthly (12), weekly (52), and daily (365).