Question

10. Which one of the following statements related to loan interest rates is correct?

		The annual percentage rate considers the compounding of interest.
		When comparing loans with different compounding periods you should compare the effective annual rates.
		Lenders are more likely to quote the effective annual rate.
		The more frequent the compounding period, the lower the effective annual rate given a fixed annual percentage rate.

3 points   

Answer 1

Solution

Answer-When comparing loans with different compounding periods you should compare the effective annual rates.

Whenever the loans are being compared the effective rate should be compared and not the APR or nominal rate as the nominal rate dos not give the actual rate of intrest.The actual rate of intrest is given by effective annual rate.The formula for same is given below

Effective annual rate=(1+APR/number of compounding periods in an year)^number of compounding periods in an year-1

Thus more the compounding periods more is the effective rate

The lenders usually quote the APR and not the effective rate as the APR is a lower number as compared to Effective rate

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