Answer to Question #304473 in Management for Tryth

Question

Using a practical example, explain what is meant by an Effective Annual Interest Rate?

Answer 1

Effective annual interest rate reflects the real return on an interest-paying investment after the impacts of compounding over time are taken into consideration. It also depicts the real rate owed in interest on a loan or any other debt. EAR can accurately provide information for investments that have annual interest rates and different compounding periods. For instance, a loan with 7.64% interest compounded quarterly and one with 7.12% interest compounded monthly, the effective annual interest can determine the true interest rate on both loans.