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CMA Foundation · Fundamentals of Business Mathematics and Statistics · Time Value of Money and Annuity - Simple and Compound Interest

A nominal rate of 8% per annum is compounded quarterly. Which expression gives the effective annual rate?

The effective annual rate is (1.02)^4 - 1, about 8.24%. The nominal 8% divided by four quarters gives 2% per quarter, and compounding that for four quarters in a year gives the effective annual rate.

  1. A(1.02)^4 - 1Correct
  2. B(1.08)^4 - 1
  3. C(1.04)^2 - 1
  4. D(1.02)^2 - 1

Explanation

Quarterly rate = 8/4 = 2% = 0.02. Four quarters make a year, so effective rate = (1.02)^4 - 1, about 8.24%. (1.04)^2 - 1 would apply to half-yearly compounding.

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