\[EAR = \left(1+\frac{r}{n}\right)^n - 1\]
Variables
EAReffective annual rate
rnominal annual interest rate
nnumber of compounding periods per year
Description
What is this formula?
The effective annual rate formula calculates the true annual interest rate after considering the effect of compounding periods within a year.
When to use it
Use this formula to compare financial products with different compounding frequencies.
Example
If the nominal annual interest rate is 12% compounded monthly:
EAR = (1 + 0.12/12)^12 - 1 ≈ 0.1268
The effective annual rate is approximately 12.68%.
Applications
Banking, loans, investment comparison, credit analysis, and financial planning.