CFA Level I · CFA Level I Exam · Types of Financial Returns
An investment has a stated annual rate of 6% compounded continuously. The effective annual rate is closest to:
With continuous compounding the effective annual rate is e^r - 1. For r = 6%, e^0.06 - 1 is about 6.18%. Monthly compounding would give about 6.17% or 6.09% depending on the setup, but continuous compounding gives the highest figure, 6.18%.
- A6.00%
- B6.09%
- C6.18%Correct
Explanation
EAR = e^0.06 - 1 = 1.061837 - 1 = 6.18%. The 6.09% option is the EAR under monthly compounding, (1+0.005)^12 - 1, so it uses the wrong compounding frequency. The 6.00% option ignores compounding altogether.
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