Chapter 3

]Mathematics For Management And Finance[

Effective rate
: APR: annual percentage rate

Nominal rate that is compounded

monthly

AER: annual effective rate : (f)

Interest rate compounded annually

:NOTE

AER is used to compare one interest rate with another interest rate
compounded at different intervals

j
( 1+i )m−1 i=
m =F

J: given nominal rate

M: number of conversion periods in one year

F: equivalent effective rate

:Note

By comparing the effective rate of various sources, a person may

:select one having

the lowest effective rate for borrowing *

the highest effective rate for investing *

:Ex
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 Chapter 3
]Mathematics For Management And Finance[

Find the effective rate if money is worth 6% compounded quarterly on the

investment market

Sol

J=6% m=4

j 6% ( 1+i )m−1
= =F= i
m 4

( 1+
4)
6% 4
−1=f

f=1.06136 -1

f=0.06136

f=6.14%

:Ex

Bank A offers its depositors an interest rate of 6% compounded monthly, while

1
bank B gives its depositors an interest rate of 6 2 % compounded semiannually.
Which of the two banks makes the better offer

:Sol

The better offer for depositors (investment)is the offer with higher AER

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 Chapter 3
]Mathematics For Management And Finance[

:Bank A

J=6% m=12
1 j 6%
%= = =i
2 m 12

( 1+i )m−1=F

( ) −1=f
12
6%
1+
12

f=1.0617 – 1

f=.o617=6.17%

Bank B
1
m=2 j=6 2 %

1
6 %
j 2 =i
=
m 2

( 1+i )m−1=F

( )
2
1
6 %
−1=f
2
1+
2

f= 1.0661 - 1

% f= 0.0661= 6.61

bank B gives a higher effective rate for depositors

:NOTE

If m=1

F=i=j

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Chapter 3
]Mathematics For Management And Finance[

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