Hello, I need help with a few questions. The answers are here as well. And yes,

Question

Hello, I need help with a few questions. The answers are here as well. And yes, these questions are in relation to the questions posted in the picture A, B and C, respectively.

A) They converted the effective annual rate (EAR) to an annual percentage rate (APR) and then divided by 12 to find the monthly rate. Why not 11.22% (EAR) divided by 12 =0.935%?

B) Here they used the annual percentage rate divided by 12 = 0.89% for the monthly rate. Why did they use compounding period per year as 1 and not 12? (C/Y 1) instead of (C/Y 12) on a financial calculator?

C) Same thing here. Why did they use compounding period per year as 1 and not 12?

Thanks.

Example 12.2: Mwangi Ndegwa offers the best price in town on used cars. Even better, you can pay in 36 easy, low, low monthly instalments, at an effective annual interest rate of only 11.22%. The APR (annual percentage rate) does not allow for the monthly compounding, while the EAR fective annual rate) does. See Chapter 2 if you need to review time value of money

Explanation / Answer

ANSWER (a) :

EVERY COMPANY GENERALLY DISPLAYS THE APR (ANNUAL PERCENTAGE RATE).

APR IS NOTHING BUT SIMPLE YEARLY RATE.

E.G., IF APR IS 12 %, MONTHLY RATE = 1% (12%/12)

BUT WHEN WE PAY MONEY EVERY MONTH, WE HAVE TO DO COMPOUNDING TO ARRIVE AT EFFECTIVELY WHAT WE PAY

HERE IN OUR SUM, THEY HAVE GIVEN EFFECTIVE RATE,

SO FIRST OF ALL WE HAVE TO CONVERT IT IN APR (YEARLY), THEN WE HAVE TO DIVIDE IT BY 12 TO ARRIVE AT MONTHLY APR.

IF WE PAY MONEY YEARLY, THEN EFFECTIVE RATE AND APR BOTH WILL BE EQUAL.

IF WE PAY MONEY OTHER THAN YEARLY, EFFECTIVE RATE WILL BE HIGHER THAN APR.

ANSWER (b) :

IN THIS CASE, WHEN WE USE EXCEL, IT WILL CLEAR YOUR DOUBT

YOU HAVE TO ENTER IN EXCEL

NPER= 3*12 = 36

RATE = 10.68%/12 =0.89%

SO CALCULATOR DOES THE SAME THING, BECAUSE IF WE TAKE MONTHLY RATE =0.89%, IT IS EQUAL TO 36 PERIODS EACH OF 1 COMPONDING ONLY,

ANSWER (c ) :

I WILL EXPLAIN IT AGAIN

IF WE USE MONTHLY APR, THEN ALWAYS COMPOUNDING WILL BE TAKEN AS 1

SAME WAY, IF WE USE QUARTERLY APR, THEN COMPOUNDING WILL BE 12/4 = 3

IF WE USE MONTHLY APR, THE COMPOUNDING WILL BE 12/12 = 1

AS I SAID, CALCULATOR DOES IT DIRECTLY, EXCEL DOES IT INDIRECTLY.

STILL DOUBTS, FEEL FREE TO ASK. THUMBS UP PLEASE

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