Vito Corleone will loan you money on a “ten-for-twelve” arrangement; i.e., for every $10 he gives...

Vito Corleone will loan you money on a “ten-for-twelve” arrangement; i.e., for every $10 he gives you today, you give him $12 on payday, which is two months from now. What is the EAR of this loan?

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Expert Solution

For 2 Month,

Return = (Price at the end - Initial price)/ Initial Price

= (12-10)/10

= 2/10

= 0.02 or 2%

Number of periods = 12 Months / 2 Months

= 6

Effective annual rate =[ (1+Interest rate per period)^Number of period ] -1

= (1+2%)^6 -1

= 1.02^6 -1

= 1.12616241926 -1

= 0.1262 or 12.62%

Effective annual rate = 12.62%

jeff jeffy answered 2 years ago

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