- Enter the Nominal Interest Rate and Compounding Frequency.
- Click "Calculate EAR" to calculate the Effective Annual Rate (EAR).
- Your calculation history will be displayed below.
- Click "Clear Results" to reset the inputs and results.
- Click "Copy Results" to copy the EAR to the clipboard.
The Effective Annual Rate (EAR) is calculated using the following formula:
EAR = (1 + (Nominal Rate / Compounding Frequency)) ^ Compounding Frequency - 1
Where:
- Nominal Rate: The nominal interest rate in percentage.
- Compounding Frequency: The number of times interest is compounded per year.
The formula calculates the annual interest rate that takes into account the effect of compounding over the year.
The Effective Annual Rate (EAR) is the rate of interest actually earned on an investment or paid on a loan as a result of compounding the interest over a given period of time. It is higher than the nominal rate and used to compare different financial products with different compounding periods.
Concepts
The Effective Annual Rate is the true rate of return on an investment or loan because it takes into account the effects of compounding. The more frequent the compounding periods, the higher the rate. A savings account or a loan may be advertised with both a nominal interest rate and an effective annual interest rate. The nominal interest rate does not reflect the effects of compounding interest or even the fees that come with these financial products. The effective annual interest rate is the real return. That’s why the effective annual interest rate is an important financial concept to understand.
Formulae
The following formula is used to calculate the Effective Annual Rate:
Effective Annual Rate = (1 + (nominal interest rate / number of compounding periods)) ^ (number of compounding periods) – 1
For example, Union Bank offers a nominal interest rate of 12% on its certificate of deposit to Mr. Obama, a bank client. The bank compounds the interest on a monthly basis. The effective annual rate for this investment is calculated as follows:
Effective Annual Rate = (1 + (0.12 / 12)) ^ 12 – 1 = 12.68%
Benefits
The Effective Annual Rate has several benefits. It allows investors to compare different financial products with different compounding periods. It also helps investors to understand the true rate of return on their investments. The Effective Annual Rate is also useful for calculating the true cost of borrowing money.
Interesting Facts
- The Effective Annual Rate is also known as the annual equivalent rate (AER).
- The Effective Annual Rate is the true rate of return on an investment or loan because it takes into account the effects of compounding.
- The Effective Annual Rate is higher than the nominal rate.
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