Question

Suppose Community Bank offers to lend you $10,000 for one year at a nominal annual rate of 6.50%, but you must make interest payments at the end of each quarter and then pay off the $10,000 principal amount at the end of the year. What is the effective annual rate on the loan? a. 5.39% b. 6.66% c. 8.26% d. 6.73% e. 7.99%

Answer 1

Answer:

The correct answer is option (B).

Explanation:

According to the scenario, the given data are as follows:

Loan amount = $10,000

Nominal annual rate = 6.50%

Time =  1 year = 4 Quarter

So, the effective annual rate on the loan can be calculated by using following formula:

Effective annual rate = (1 + Nominal Rate/Time)^Time -1

= (1+ 6.5%/4)^4 - 1

= 6.66%

Hence, Effective annual rate on the loan is 6.66%.