Question

Suppose that Community Bank offers to lend you $10,000 for one year at a nominal interest rate of 8.00%, but you must make interest payments at the end of each quarter and then pay off the $10,000 principal amount at the end of the year. What is the effective annual rate of the loan?

a. 8.24%
b. 8.45%
c. 8.66%
d. 8.88%
e. 9.10%

Answer 1

Answer:

a. 8.24%

Explanation:

The formula to compute the effective annual rate of the loan is shown below:

= (1 + nominal interest rate ÷ periods)^ number of period - 1

= (1 + 8% ÷ 4)^4 - 1

= (1 + 2%)^4 - 1

= 1.02^4 - 1

= 8.24%

As the interest rate is made on a quarterly basis and we know that there are four quarters in a year and we take the same in the computation part