Explain the difference between the Annual Percentage Rate (APR) and the Effective Annual Percentage Rate (EAR).

What would cause the EAR to be greater than the APR?
When would the APR and EAR be the same?
Can the APR ever be greater than the EAR?

Solutions

Expert Solution

When the frequency compounding of interest rate is more than one for a year then the effective annual percentage rate (EAR) is used instead of annual percentage rate (APR). APR is quoted interest rate while EAR is effective interest rate which is actually paid.

Effective annual rate (EAR) = (1 + APR/m) ^m – 1

Where,

Effective annual percentage rate =EAR

Annual percentage rate = APR

Number of compounding period per year = m

What would cause the EAR to be greater than the APR?

The frequency of compounding of interest rate cause the EAR to be greater than the APR

When would the APR and EAR be the same?

When the frequency of compounding of interest rate is one (m=1; in above formula) then the APR and EAR be the same

Can the APR ever be greater than the EAR?

No, the APR cannot be greater than the EAR. APR could be either less or equal to EAR.

jeff jeffy answered 1 year ago

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