Question #3: Interest rates are quoted either as Annual Percentage Rate (APR) or Effective Annual Rate...

Question #3: Interest rates are quoted either as Annual Percentage Rate (APR) or Effective Annual Rate (EAR)

Required: What is the difference between an Annual Percentage Rate and an Effective Annual Rate?

Solutions

Expert Solution

Banks and financial institutions are required to disclose their interest rate for borrowing, to the customers.

Annual Percentage Rate (APR) is the interest rate charged per period for a loan multiplied by the number of payment periods in a year. For example, if the interest rate for a car loan is 1% per month, its APR will be 12%. The method of calculating APR is fixed by law.

Interest rate

No of periods

Effective Annual Rate (EAR) is also called Annual Effective Yield. It is the measure of opportunity cost of the interest by considering the effect of periodic compounding.

Interest rate

No of periods in a year

While APR considers simple interest rate, EAR considers the compounding effect. So EAR will be always higher than APR

jeff jeffy answered 1 year ago

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