Question

5. The effective rate of interest associated with a 6 percent nominal rate of return when interest is compounded monthly is:

a. 6.14 percent 2 b. 6.17 percent c. 6.09 percent d. 6.00 percent

Answer 1

Effective Annual Rate

Effective annual rate is the rate of interest an investor earns in a year after accounting for the effects of compounding.

It is calculated using the below formula:

EAR= (1+r/n)^n-1

Where r is the interest rate and n is the number of compounding periods in one year.

EAR= (1+0.06/12)^12-1

        = 1.0617-1

        = 0.0617*100= 6.17%

Therefore, the effective annual rate is 6.17%.