Overview

Effective annual interest rate (EAR), also referred to as effective interest rate or effective rate, is the interest rate adjusted for compounding for a given period of time. It is the annual rate of interest which investors is expected to earn or the rate at which borrowers has to pay the lender. The formula for calculating the effective annual interest rate is as follows:

EAR = (1 + i / n)^n - 1

Where:

i = stated annual interest rate

n = number of compounding periods

The EAR is always higher than the stated annual interest rate and is an important metric used by investors to compare investments and determine which generates the highest rate of return.

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