Question

Required:

Banks, credit card companies, and other lenders, state interest rates that are compounded with a frequency not equal to annual, e.g. compounded monthly, etc... There are 'historical' reasons for quoting rates in such a manner, but no matter. How does the quoted rate affect the amount of interest you would pay for a monthly car or home loan? Write 100 words.

What kind of experiences do you have with a provider of credit listing rates, and then attempting to explain that stated rate in terms of 'actual,' or 'effective,' terms? Write 100 words.

Please write in your own words. Please don't copy from anywhere.

Answer 1

Banks, credit card companies, and other lenders, state interest rates that are generally compounded monthly.
How its impact on yearly interest rate?
Suppose credit card company charged interest rate 12% per year. If credit card company charged monthly interest means monthly compounded. Monthly interest rate @ 1% but how this 1% interest rate affects yearly interest rate?
Suppose taken credit from credit card company $100 in beginning of year.
If company charged yearly compounding then interest expense = 100*12% =12.
If company charged monthly interest then
Months	Beginning balance	Interest expense @ 1 % of beginning balance	Ending balance
1	100.00	1.00	101.00
2	101.00	1.01	102.01
3	102.01	1.02	103.03
4	103.03	1.03	104.06
5	104.06	1.04	105.10
6	105.10	1.05	106.15
7	106.15	1.06	107.21
8	107.21	1.07	108.29
9	108.29	1.08	109.37
10	109.37	1.09	110.46
11	110.46	1.10	111.57
12	111.57	1.12	112.68
At end of year you required to pay amount of			112.68
Less: paid for principal			100
Interest expense			12.68
Now you can understand, interest expense as per yearly compounding is $ 12 while interest expense as per monthly compounding is $ 12.68
Actually credit card company charged interest @ 12%
But effective rate of interest is 12.68%