Question

All else equal, the effective annual rate of interest for a bank loan paid back in quarterly installments will be ________ A bank loan paid back in monthly installments.

A. Less than

B. More than

C. Equal to

D. The answer cannot be determined from the information provided

Answer 1

Answer: A. Less than

All else equal, the effective annual rate of interest for a bank loan paid back in quarterly installments will be Less than A bank loan paid back in monthly installments.

Explanation:

Effective Annual Rate (EAR) = [(1+(r/m))^m] - 1

[m = compounding period; r = interest rate]

Considering an example, r = 15%,

Case 1:Quarterly Compounding, (m = 4)

EAR_Q = [(1+(0.15/4))⁴] - 1 =15.865%

Case 2:Monthly Compounding, (m = 12)

EAR_M = [(1+(0.15/12))¹²] - 1 =16.075%

Therefore, EAR_Q < EAR_M