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A credit card advertisement states that the annual percentage rate is 21 percent
A credit card advertisement states that the annual percentage rate is 21 percent. If the credit card requires quarterly payments, what is the effective annual rate of interest on the loan?
Show your work including Variables and Formulas. Be as detailed as possible.
Expert Solution
Effective Annual Rate (EAR): It is a technique of measuring time value of money. This technique is used to estimate the cost of loan or the annual income from the investment held. Through Effective annual rate is estimated with additional fees or charges compounding, this is done to know the annualized actual cost of loan as the banks or lending firms may charge extra financing charges following the time. Thus the EAR approach gives out a comprehensive expression for the annualized loan cost.
The APR of bank credit card is 21% and is compounded quarterly.
The formula to evaluate EAR is,
Where,
EAR- Effective Annual Rate
APR- Annual Percentage Rate
CY- Compounding tenure for year
With the substitution of given values in the above formula EAR is found as,
EAR = (1+0.21/4)^4-1
= (1+0.0525)^4-1
= 0.227124
= 22.71%
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