CFA Level I · CFA Level I Exam · The Time Value of Money in Finance
A loan has a stated annual rate of 12% compounded monthly. The effective annual rate is closest to:
The effective annual rate is about 12.68%. A 12% stated rate compounded monthly is 1% per month, and (1.01) raised to the 12th power equals 1.1268, so the annual effective rate exceeds the stated rate because of compounding.
- A12.00%
- B12.68%Correct
- C12.99%
Explanation
Monthly rate = 12%/12 = 1%. EAR = (1.01)^12 - 1 = 1.126825 - 1 = 12.68%. The 12.00% choice ignores compounding, while 12.99% would be roughly the result for daily-type or higher compounding errors.
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