Is the effective annual rate determined by multiplying the interest rate charged per period by the number of periods in a year?

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lemjay | High School Teacher | (Level 2) Senior Educator

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Not really. Computation for effective annual rate is different from converting one unit to the other.

As the name implies, it is the equivalent annual rate of an interest that is compounded more than once in a year. The formula is:

r = [1 + (i/n)]^n - 1

where r - is the effective annual rate

         i  - annual interest rate    

         n  - number of compounding periods.

Effective annual rate is used to compare interests with different compounding frequencies. It helps an investor or a borrower to determine which among the choices would yield a higher future value.


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