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AER Formula:
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The Effective Annual Interest Rate (AER) represents the actual annual rate of return when compounding is taken into account. It provides a more accurate measure of the true cost of borrowing or the true return on investment compared to the nominal annual rate.
The calculator uses the AER formula:
Where:
Explanation: The formula accounts for the effect of compounding by showing how interest earned in previous periods also earns interest in subsequent periods.
Details: AER is crucial for comparing different financial products with different compounding frequencies. It helps investors and borrowers understand the true annual cost or return, enabling better financial decision-making.
Tips: Enter the annual nominal interest rate as a percentage (e.g., 5 for 5%) and the number of compounding periods per year. All values must be valid (rate > 0, frequency ≥ 1).
Q1: What's the difference between nominal rate and effective rate?
A: The nominal rate doesn't account for compounding, while the effective rate shows the actual annual return/cost including compounding effects.
Q2: How does compounding frequency affect AER?
A: More frequent compounding results in a higher effective annual rate, as interest is calculated and added more often.
Q3: When is AER most important to consider?
A: When comparing loans, savings accounts, or investments with different compounding periods, AER provides a standardized comparison.
Q4: Can AER be lower than the nominal rate?
A: No, AER is always equal to or higher than the nominal rate due to the compounding effect.
Q5: How is this related to BA II Plus calculator?
A: This calculation mimics the effective annual rate function available on financial calculators like the BA II Plus, which is commonly used in finance and investment analysis.