Question

What is the effective annual rate​ (EAR)? A. It refers to the cash flows from an investment over a oneminusyear period divided by the number of times that interest is compounded during the year. B. It is the interest rate for an nminusyear time​ interval, where n may be more than one year or less than or equal to one year​ (a fraction). C. It is the interest rate that would earn the same interest with annual compounding. D. It is the ratio of the number of the annual percentage rate to the number of compounding periods per year.

Answer 1

Answer:

C. It is the interest rate that would earn the same interest with annual compounding

Explanation:

$(1+r_e)^{n} = (1+r/m)^{n\times m}$

Is the rate which offers the same yields of a rate with compounding.

For example:

if a rate of 10% coumpound semiannually the effective rate will be

$(1+r_e)^{1} = (1+0.10/2)^{1\times 2}$

$r_e= (1.05)^{2}-1$

$r_e= 1.1025-1 = 10.25$

An annual rate of 10.25 will be equivalent of a 10% rate compounding semianually.