Identify the correct expression for the effective annual rate (EAR).
A) (1 + Periodic rate of interest)number of borrowing (interest) periods in one year - 1
B) (1 / Periodic rate of interest)number of borrowing (interest) periods in one year - 1
C) (1 - Periodic rate of interest)number of borrowing (interest) periods in one year - 1
D) (1 + Periodic rate of interest)number of borrowing (interest) periods in one year + 1
E) (1 - Periodic rate of interest)number of borrowing (interest) periods in one year + 1

Question

Quizplus · Accepted Answer

The correct expression for the effective annual rate (EAR) is (1 + Periodic rate of interest)number of borrowing (interest) periods in one year - 1. This formula takes into account compounding, or the interest earned on interest. Option B divides by the periodic rate, which is incorrect. Option C subtracts the periodic rate, which also does not result in the correct expression for EAR. Option D adds 1 at the end, which is not necessary. Option E subtracts the periodic rate, which is also incorrect.

Identify the Correct Expression for the Effective Annual Rate (EAR)