Question

An account with an initial balance of $4,000.00 and a 3% interest rate has a balance of $4,121.66 at the end of one year. What is the effective annual yield? A. 97.05% C. 3.00% B. 2.95% D. 3.04%​

Answer 1

The effective annual yield is 3.04%

What is effective annual yield?

Effective annual yield is the rate of return that considers the frequency of compounding, in other words, the number of times in a year that interest on the balance is compounded.

The easiest way to determine the effective annual yield in this case is to compare the end of the year balance with the initial balance at the start of the year

effective annual yield=(ending balance/initial balance)-1

ending balance=$4,121.66

initial balance=$4000

effective annual yield=($4,121.66/$4000)-1

effective annual yield=3.04%

Another way to determine the effective annual yield is use the below formula which considers that interest rate is 3% compounded monthly, in other words, n, the frequency of compounding is 12

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

r=3%

n=12

EAR=(1+3%/12)^12-1

EAR=3.04%

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