Question

Payday loans are very short-term loans that charge very high interest rates. You can borrow $200 today and repay $210 in one week. What is the effective annual rate (EAR) implied by this 5 percent rate charged for only one week

Answer 1

Answer:

effective annual rate = 1164.28%

Explanation:

effective annual rate = (1 + i)ⁿ - 1

• i = weekly interest rate = 5%
• n = number of weeks in a year = 52 weeks

effective annual rate = (1 + 0.05)⁵² - 1 = 12.6428 - 1 = 11.6428 = 1164.28%

Sadly this question is probably taken from a real world case. Payday loans are infamous for their extremely high interest rates. They can help someone cover some immediate expense, but their customers are digging their financial graves. That is why they are forbidden in many states.