A single sum of money #A, to be set aside and invested now,with interest compounded every six months ,how much should this single sum be and what is the effective annual rate of interest?

Virtuestar

4 years ago

The effective annual rate is normally higher than the nominal rate because the nominal rate quotes a yearly percentage rate regardless of compounding. Increasing the number of compounding periods increases the effective annual rate as compared to the nominal rate. To spin it in another light, an investment that is compounded annually will have an effective annual rate that is equal to its nominal rate. However, if the same investment was instead compounded quarterly, the effective annual rate would then be higher.



What is the Formula for the Effective Annual Rate?
The formula for the EAR is:

Effective Annual Rate = (1 + (nominal interest rate / number of compounding periods)) ^ (number of compounding periods) – 1