Question

You would be making a wise decision if you chose to:________.
a. base decisions regarding investments on effective rates and base decisions regarding loans on annual percentage rates.
b. assume all loans and investments are based on simple interest.
c. accept the loan with the lower effective annual rate rather than the loan with the lower annual percentage rate.
d. invest in an account paying 6 percent, compounded quarterly, rather than an account paying 6 percent, compounded monthly.
e. ignore the effective rates and concentrate on the annual percentage rates for all transactions.

Answer 1

Answer:

c. accept the loan with the lower effective annual rate rather than the loan with the lower annual percentage rate.

Explanation:

In the above scenario it will be a good financial decision to choose a loan with lower effective rate than the one with lower percentage rate.

Effective rate is defined as the real interest rate on a loan or the actual amount that is to be repaid annually on a loan. It gives a truer picture of cost of borrowing money.

Percentage rate is interest paid on a loan expressed as a percentage of the total amount collected. It usually includes various fees and charges collected by the lender. So it is not a true reflection of the cost of borrowing

Answer 2

Answer:

c. accept the loan with the lower effective annual rate rather than the loan with the lower annual percentage rate.

Explanation:

The effective annual rate is the actual rate of interest that you will have to paid on the loan. The effective annual rate takes into account the compounding interest over the loan's period of time.

An annual percentage rate can be either nominal (without taking compounding into account), or effective. For this reason, to make sure that you are making the most rational decision, you should take the loan with the lower effective annual rate, because the lower annual percentage rate may be either nominal or effective.