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APY Formula:
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The APY (Annual Percentage Yield) formula calculates the effective annual rate of return taking into account the effect of compounding interest. It provides a more accurate representation of the actual return on investment compared to the nominal interest rate.
The calculator uses the APY formula:
Where:
Explanation: The formula accounts for the compounding effect by raising the periodic rate to the power of the number of compounding periods and subtracting 1 to get the effective annual yield.
Details: APY calculation is crucial for comparing different investment options and understanding the true annual return on certificates of deposit (CDs) and other interest-bearing accounts.
Tips: Enter the nominal interest rate as a decimal (e.g., 0.05 for 5%) and the number of compounding periods per year as an integer. All values must be valid (r ≥ 0, n > 0).
Q1: What's the difference between APR and APY?
A: APR (Annual Percentage Rate) doesn't account for compounding, while APY (Annual Percentage Yield) includes the effect of compounding, giving a more accurate measure of return.
Q2: How does compounding frequency affect APY?
A: More frequent compounding results in a higher APY for the same nominal interest rate, as interest is earned on previously earned interest more often.
Q3: What are typical APY values for CDs?
A: CD APY rates vary by institution and term length, but typically range from 0.5% to 5% depending on market conditions and the length of the CD term.
Q4: Can APY be negative?
A: While theoretically possible with negative interest rates, most CDs and savings accounts offer positive APY to ensure depositors earn interest on their funds.
Q5: How should I use APY when comparing CDs?
A: Always compare APY rather than nominal rates, as APY gives you the true annual return accounting for compounding frequency differences between offers.