Table of contents

1. Introduction to Accounting1h 21m
2. Transaction Analysis1h 13m
3. Accrual Accounting Concepts2h 38m
4. Merchandising Operations2h 30m
5. Inventory1h 55m
6. Internal Controls and Reporting Cash1h 16m
7. Receivables and Investments3h 8m
8. Long Lived Assets5h 1m
9. Current Liabilities2h 19m
10. Time Value of Money1h 23m
- Time Value of Money Equations
  35m
- Using Time Value of Money Tables
  47m
11. Long Term Liabilities2h 45m
12. Stockholders' Equity2h 15m
13. Statement of Cash Flows2h 24m
14. Financial Statement Analysis5h 25m
15. GAAP vs IFRS56m

10. Time Value of Money

Time Value of Money Equations

Financial Accounting

10. Time Value of Money

Time Value of Money Equations

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Multiple Choice

If an account compounds interest monthly at a nominal rate of 2.5\% per year, what is the effective annual rate (EAR) for the account?

2.53\%

2.42\%

2.50\%

2.60\%

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Verified step by step guidance

Step 1: Understand the concept of Effective Annual Rate (EAR). EAR accounts for the effect of compounding within a year and is calculated using the formula: EAR = (1 + r/n)^n - 1, where r is the nominal annual interest rate, and n is the number of compounding periods per year.

Step 2: Identify the given values from the problem. The nominal annual interest rate (r) is 2.5% or 0.025 in decimal form, and the account compounds interest monthly, so the number of compounding periods per year (n) is 12.

Step 3: Substitute the values into the EAR formula. Using MathML, the formula becomes:

{(1 + \frac{0.025}{12})}^{12} - 1

Step 4: Simplify the expression inside the parentheses first. Divide the nominal rate (0.025) by the number of compounding periods (12) to find the monthly interest rate.

Step 5: Calculate the EAR by raising the simplified value to the power of 12 (the number of compounding periods per year) and subtracting 1. This will give the effective annual rate, which can then be compared to the provided answer choices.