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Effective Interest Rate (EIR) are use to compare securities and investments with different compounding cycle or life.

 

Effective Interest Rate when Annual Percentage Rate is given

effective interest rate formula

 

Example 1:

You decide to borrow Rs. 30,000 to buy a stereo system and a CD.  Lending rates of three major banks are:

MCB Bank                                                           8% p.a. compounded quarterly

National Bank                                                     8% p.a. compounded semi-annually

Allied Bank                                                           8% p.a. with daily compounding

You will go to a bank with lowest lending cost.  To which bank would you go?

effective interest rate example

 

Annual Percentage Rate when Effective Interest Rate is given

annual percentage rate formula



Example 2:

If you pay 1.5% per month EIR on the outstanding balance of your Master card bill, what APR are you being charged?

annual percentage rate example

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References

Financial Management: Theory and Practice, Dr Eugene F Brigham & C Micheal Ehrhardt

Fundamentals of Financial Management: Concise Edition, Brigham Houston

The Economist Guide to Financial Management, John Tennet

Financial Management: Core Concepts, Raymond M Brooks

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