Question

The bank quoted interest rate is 4% per annum. Find the six month rate ? Is it (1+4%)^0.5 or is it (1+4%/2) ? Explain your answer

Answer 1

Here, Annual rate is given which compounded semiannualy hence effective annual rate to be calculated,

Effecetive annual rate if compounded semiannually then ,

Effective Interest rate = (1+(r/n))^n - 1

Where r = interest rate = 4%

n = number of period = 2

Therefore effective annual rate = (1+(4%/2))^2 -1 = 4.04%

Formula to calculate the 6 month(semiannual) rate,

=(1+r%)^(n/2) - 1

where r = annual rate

n = number of years

= (1+4%)^(1/2) - 1

= (1+4%)^0.5 - 1

Semiannual Interest rate(6-Month) = 1.98%