What is the correct way to annualize an interest rate in financial dec
QUESTION
What is the correct way to annualize an interest rate in financial decision making?
ct of time value of money and compounding. It is an interest rate which is expressed as if the amount is compounded once a year. EAR = (1 Quoted rate/m) 1; where m is the number of compounding periods in a year. A 12% per annum interest rate (APR), compounded monthly would give an effective rate of (1 0.12/12)-1 i.e. 12.6825%. So, in effect the borrower pays more than the stated rate of interest. In reality, compound interest is used to calculate the interest amounts on investments, hence EAR is the correct method to annualize an interest rate in financial decision making.
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