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Forums › ACCA Forums › ACCA MA Management Accounting Forums › Annual effective interest rate
Dear John,
An investor has the choice between two investments. Investment Exe offers interest of 4% per year
compounded semi-annually for a period of three years. Investment Wye offers one interest payment of 20% at the end of its four-year life.
What is the annual effective interest rate offered by the two investments?
Investment Exe Investment Wye
A 4·00% 4·66%
B 4·00% 5·00%
C 4·04% 4·66%
D 4·04% 5·00%
Correct Answer is C.
I could not understand that why for finding effective annual rate for investment Exe we use formula r= (1+i/n)-1 and for other we use r=(1+r)^n-1.
Thank you
There are not two formulae – it is the same formula!
In the case of Exe, the interest is 2% every six months (4%/2).
So if the annual effective rate is R, then 1+R = 1.02^2 = 1.0404. So R = 0.404 or 4.04%
In the case of Wye, again if the annual effective rate is R, then (1+R)^4 = 1.20
So, 1+R = fourth root of 1.20 = 1.0466. So R = 0.0466 or 4.66%
Thank you so much.
You are very welcome 🙂
sorry sir i didnt get it.
can you plz explain why u did 4*6/12 for exe?
i didnot get it for wye too. can you plz explain more in detail.