Effective annual rate

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Revision as of 17:48, 3 December 2015 by imported>Doug Williamson (Remove the material transferred to the new page Calculating Effective annual rates.)
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(EAR).

1.

A quoting convention under which interest at the quoted rate is calculated and added to the principal annually.

EAR is the most usual conventional quotation basis for instruments with maturities of greater than one year.


2.

A conventional measure which expresses the returns on different instruments on a comparable basis.

The EAR basis of comparison is the equivalent rate of interest paid and compounded annually, which would give the same all-in rate of return as the instrument under review.

For this reason, 'EAR' is sometimes expressed as equivalent annual rate.


Conversion formulae

r = R / n


Where:

r = periodic interest rate or yield

R = nominal annual rate

n = number of times the period fits into a conventional year (for example, 360 or 365 days)


EAR = (1 + r)n - 1


Where:

EAR = effective annual rate or yield

r = periodic interest rate or yield, as before

n = number of times the period fits into a calendar year


Calculating EAR from GBP overnight quote

Example: EAR from overnight quote

GBP overnight interest is conventionally quoted on a simple interest basis for a 365-day year.

So GBP overnight interest quoted at R = 5.11% means:

(i)

Interest of:

r = R / n

r = 5.11% / 365

r = 0.014% (= 0.00014) is paid per day.


(ii)

The equivalent effective annual rate is calculated from (1 + r).

1 + r = 1 + 0.00014 = 1.00014


EAR = (1 + r)n - 1

EAR = 1.00014365 - 1

EAR = 5.2424%.


See also