Question

Consider an account with an APR of 4.6​%. Find the APY with quarterly​ compounding, monthly​ compounding, and daily compounding. Comment on how changing the compounding period affects the annual yield

Answer 1

APR = 4.6%
Compounding period per year	Effective rate calculation	Effective Annual rate
Quarterly	=(1+ (4.6%/4))^4 - 1	4.68%
Monthly	=(1+ (4.6%/12))^12 - 1	4.70%
Daily	=(1+ (4.6%/365))^365 - 1	4.71%
We can see from above table that as compounding period increases the effective interest rate increases. This is called as compounding effect. As payment is received more than once in a year it is available for reinvestment by which we can maximize the effective interest rate.