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Effective Interest Rates
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Annual Percentage Rates
Banks also quote interest rates in terms of APR,
which indicates the amount of simple interest earned
in one year, that is the amount of interest earned
without the effect of compounding. Because it does
not include the effect of compounding, the APR quote
is typically less than the actual amount of interest
that you will earn. To compute the actual amount
that you will earn in one year, the APR must first be
converted to an effective annual rate.
EAR = (1 + APR/m)m 1
APR does not reflect the true amount you will earn
over one year
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EAR & APR Calculations
Annual Percentage Rate (APR):
APR MR 12 *where MR:
monthly interest rate
Effective Annual Interest Rate (EAR):
EAR (1 APR / m) 1
m
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Example
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You are considering purchasing a new automobile
that will cost you $28,000. The dealer offers you
4.9% APR financing for 60 months (with
payments made at the end of the month).
Assuming you finance the entire $28,000 and
finance through the dealer, your monthly
payments will be closest to: