Question

Define these business finance terms in your own words and then give a real world example of each: Effective Annual Rate (EAR), Interest-Only Loans, Perpetuity, Pure Discount Loans, Quoted Interest Rate.

Answer 1

A. Effective annual rate is the rate after taking the effect of various periods and interest rate so that interest rates which has been effectively correlated with the period is undertaken as effective interest rate and it is different from flat annual interest rate.

For example, effective interest rate of 8% monthly compounding is different from effective interest of 96% of yearly compounding.

B. Interest only loan will be only offering with payment of interest for the borrower for the specific period and after that he will be making the payment for principal.

For example interest only loan of $5000000 @ 15%.

C. Perpetuity is the never-ending stream of cash flows which are received forever.

Neverending payments of 4000 per year forever is an example of perpetuity.

D. Pure discounting loans are promises to pay a certain sum of money for amount of loan which is borrowed today.

E. Quoted interest rate is nominal interest rate for annual percentage rate which does not affect for periodic changes.

For example, these interest rates are flat interest rates who does not include the effect of compounding.