Effective Annual Rate

Annual Percentage Rate vs Effective Annual Rate

• APR is a quoting convention where short-term interest rates (monthly, quarterly, semi-annually, etc.) are multiplied by the number of periods in a year.
• Not particularly useful because APR does not take into account compounding!
• An interest rate is “APR” when:
• A quotation is provided;
• Compounding frequency is indicated; or
• The periodicity of the interest rate is not annual and is not specified to be “effective” (e.g. “monthly” interest rate).
• Also called the nominal rate, stated rate, or quoted rate

• The actual interest rate that is earned or paid, computed by adjusting the APR to reflect the number of compounding periods per year.
• Effective rate increases as compounding frequency increases because interest is calculated more often.

Example: Effective Annual Rate