easy · Principles of Finance time-value-of-money
A retail bank offers a personal loan with a stated annual percentage rate (APR) of 12% compounded monthly. A competitor offers a loan with a 12.5% APR compounded annually.
Which loan has the higher effective annual rate (EAR)?
- The monthly compounded loan, because its EAR is 12.00%.
- The annually compounded loan, because 12.5% is greater than the nominal 12%.
- Both loans are identical because the 0.5% difference in APR cancels out the compounding frequency.
- The monthly compounded loan, because its EAR is approximately 12.68%.
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