Effective Annual Interest Rate (Question)
Can anyone help me solve this question?
Deposit: 1000, with annual percentage rate = 3%. What’s the effective annual interest rate if compounded monthly? Thanks a lot!
January 9th, 2009 in
Question Posted by john
Hi John,
For this question, you don’t need “deposit:1000″. It’s very common in the CFA exam that they give you more information than required.
By definition, effective annual interest rate is just “overall” interest rate when no compounding. So you want to find
(1+x) * principle = (1+3/12%)^12 * principle
Therefore x = 3.04%
Hope that helps!
(1+i/n)^n – 1
Thanks for posting the genearl formula, Mikewinner!
It is also important to point out during the CFA exam, one has to be very careful with “-1″ in certian interest rate equations and bear in mind what is the i or x your are referring to (meaning it is 3%=0.03 or 1.03). For example, in continuous compounding, if APR = 3%, the effective annual interest rate is exp(3%)-1 = exp (0.03)-1 = 3.05%. NOT exp(1.03)-1 NOR exp(1.03). Please bear that in mind!