CFA Level I · CFA Level I Exam · The Time Value of Money in Finance
A bank quotes a stated annual rate of 6% compounded monthly. The effective annual rate is closest to:
The effective annual rate is about 6.17%. Compute (1 + 0.06/12)^12 − 1 = 1.005^12 − 1. Monthly compounding earns interest on interest, so the effective rate exceeds the 6% stated rate.
- A6.00%
- B6.17%Correct
- C6.34%
Explanation
EAR = (1 + 0.06/12)^12 − 1 = 1.005^12 − 1 = 1.06168 − 1, or about 6.17%. The 6.00% figure ignores intra-year compounding. The 6.34% figure would approximate daily-plus compounding at a higher rate, not monthly at 6%.
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