Effective Annual Rate Formula:
Definition: EAR is the actual interest rate that an investor earns or pays in a year after accounting for compounding.
Purpose: It allows comparison between investments with different compounding periods by showing their true annual yield.
The calculator uses the formula:
Where:
Explanation: The nominal rate is divided by compounding periods, compounded, then converted back to annual rate.
Details: EAR reveals the true cost of loans or true yield of investments, especially when comparing products with different compounding frequencies.
Tips: Enter the nominal interest rate (as percentage) and number of compounding periods per year (default 12 for monthly). All values must be > 0.
Q1: Why is EAR higher than nominal rate?
A: Because of compounding - interest earns more interest when compounded more frequently.
Q2: What's the difference between APR and EAR?
A: APR doesn't account for compounding, while EAR does, making EAR the true rate.
Q3: How does continuous compounding work?
A: For continuous compounding, use the formula \( EAR = e^r - 1 \) where e ≈ 2.71828.
Q4: What's a typical compounding frequency?
A: Common frequencies: 1 (annual), 2 (semi-annual), 4 (quarterly), 12 (monthly), 365 (daily).
Q5: How do I calculate EAR on TI BA II Plus?
A: Use the ICONV worksheet: [2nd][ICONV], enter nominal rate [↓], set C/Y, [↓] to see EFF.