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Question 290  APR, effective rate, debt terminology

Which of the below statements about effective rates and annualised percentage rates (APR's) is NOT correct?


Answer: Good choice. You earned $10. Poor choice. You lost $10.

An APR is a discretely compounding annual rate that compounds multiple times per year.

An APR compounding once per year is an effective annual rate.

An effective rate is also a discretely compounding rate but it compounds only once per period. The time period is not necessarily annual, it can be monthly, daily, two years, or any time.

Therefore answer (c) is incorrect. An effective monthly rate is a monthly rate compounding per month.


Question 330  APR, effective rate, debt terminology

Which of the following statements about effective rates and annualised percentage rates (APR's) is NOT correct?


Answer: Good choice. You earned $10. Poor choice. You lost $10.

An APR compounding monthly is equal to 12 times the effective monthly rate. There are two steps required to convert an APR compounding monthly to an effective weekly rate:

  • Convert the APR into the effective rate that it naturally converts into, an effective monthly rate, by dividing by 12.
  • Convert the effective monthly rate into an effective weekly rate by compounding down. Add one and raise it all to the power of the inverse of the number of weeks in a month, all minus one.

The number of weeks per month is about 4, or to be more exact: 52 weeks per year divided by 12 months per year.

Mathematically:

reff monthly=rapr comp monthly12 reff weekly=(1+reff monthly)1/(number of weeks in a month)1=(1+rapr comp monthly12)1/(52/12)1

Question 16  credit card, APR, effective rate

A credit card offers an interest rate of 18% pa, compounding monthly.

Find the effective monthly rate, effective annual rate and the effective daily rate. Assume that there are 365 days in a year.

All answers are given in the same order:

reff monthly,reff yearly,reff daily


Answer: Good choice. You earned $10. Poor choice. You lost $10.

reff monthly=rapr comp monthly12=0.1812=0.015

reff yearly=(1+rapr comp monthly12)121=(1+0.1812)121=0.195618171

reff daily=(1+rapr comp monthly12)12/3651=(1+0.1812)12/3651=0.000489608


Question 26  APR, effective rate

A European bond paying annual coupons of 6% offers a yield of 10% pa.

Convert the yield into an effective monthly rate, an effective annual rate and an effective daily rate. Assume that there are 365 days in a year.

All answers are given in the same order:

reff, monthly,reff, yearly,reff, daily


Answer: Good choice. You earned $10. Poor choice. You lost $10.

Since the coupons are paid annually, by convention (and in some countries by law), we assume that the yield is an APR compounding annually. An APR compounding annually is a special case that is also an effective annual rate.

reff, monthly=(1+reff,annual)1/121=(1+0.1)1/121=0.00797414

reff, yearly=0.1 as given

reff, daily=(1+reff, yearly)1/3651=(1+0.1)1/3651=0.000261158


Question 131  APR, effective rate

Calculate the effective annual rates of the following three APR's:

  • A credit card offering an interest rate of 18% pa, compounding monthly.
  • A bond offering a yield of 6% pa, compounding semi-annually.
  • An annual dividend-paying stock offering a return of 10% pa compounding annually.

All answers are given in the same order:

rcredit card, eff yrly, rbond, eff yrly, rstock, eff yrly


Answer: Good choice. You earned $10. Poor choice. You lost $10.

rcredit card, eff yrly=(1+rcredit card, apr comp monthly12)121=(1+0.1812)121=0.195618171

rbond, eff yrly=(1+rbond, apr comp 6 monthly2)21=(1+0.062)21=0.0609

rstock, eff yrly=(1+rstock, apr comp yearly1)11=rstock, apr comp yearly=0.1


Question 662  APR, effective rate, effective rate conversion, no explanation

Which of the following interest rate labels does NOT make sense?


Answer: Good choice. You earned $10. Poor choice. You lost $10.

No explanation provided.


Question 709  continuously compounding rate, APR

Which of the following interest rate quotes is NOT equivalent to a 10% effective annual rate of return? Assume that each year has 12 months, each month has 30 days, each day has 24 hours, each hour has 60 minutes and each minute has 60 seconds. APR stands for Annualised Percentage Rate.


Answer: Good choice. You earned $10. Poor choice. You lost $10.

Since the assumptions state that there are 30 days per month and therefore 360 days per year, then the annualised percentage rate compounding per day should be:

rAPR comp daily=reff daily×360=((1+reff annual)1/3601)×360=((1+0.1)1/3601)×360=0.00026478555×360=0.095322798

Commentary

Notice that the APR's get smaller as the compounding period becomes shorter. The continuously compounded return is the limit when the compounding period is infinitely small. The APR compounding per second is nearly equal to the continuously compounded rate.

Different Return Quotations Equivalent to an Effective Annual Rate of 10%
Quote type Return (%pa) Symbol Formula Spreadsheet formula
Effective annual rate 10 reff annual =reff annual =0.1
APR compounding per annum 10 rapr comp annually =reff annual =0.1
APR compounding semi-annually 9.761769634 rapr comp 6mth =2×((1+reff annual)1/21) =2 * ((1+0.1)^(1/2)-1)
APR compounding quarterly 9.645475634 rapr comp quarterly =4×((1+reff annual)1/41) =4 * ((1+0.1)^(1/4)-1)
APR compounding monthly 9.568968515 rapr comp monthly =12×((1+reff annual)1/121) =12 * ((1+0.1)^(1/12)-1)
APR compounding daily 9.532279763 rapr comp daily =360×((1+reff annual)1/3601) =360 * ((1+0.1)^(1/360)-1)
APR compounding hourly 9.531070550 rapr comp hourly =360×24×((1+reff annual)1/(360×24)1) =360*24 * ((1+0.1)^(1/(360*24))-1)
APR compounding per minute 9.531018861 rapr comp per minute =360×24×60×((1+reff annual)1/(360×24×60)1) =360*24*60 * ((1+0.1)^(1/(360*24*60))-1)
APR compounding per second 9.531018227 rapr comp per second =360×24×60×60×((1+reff annual)1/(360×24×60×60)1) =360*24*60*60 * ((1+0.1)^(1/(360*24*60*60))-1)
Continuously compounded annual rate 9.531017980 rcc annual =ln(1+reff annual)=loge(1+reff annual) =ln(1+0.1)
 

 


Question 741  APR, effective rate

A home loan company advertises an interest rate of 4.5% pa, payable monthly. Which of the following statements about the interest rate is NOT correct?


Answer: Good choice. You earned $10. Poor choice. You lost $10.

The effective monthly rate can easily be found by dividing the APR compounding monthly by 12.

reff monthly=rAPR comp monthly12=0.04512=0.00375=0.375%pa

Question 849  credit card, APR, no explanation

You just spent $1,000 on your credit card. The interest rate is 24% pa compounding monthly. Assume that your credit card account has no fees and no minimum monthly repayment.

If you can't make any interest or principal payments on your credit card debt over the next year, how much will you owe one year from now?


Answer: Good choice. You earned $10. Poor choice. You lost $10.

No explanation provided.