Interest 04

Question 1

1. Wikipedia-INTEREST RATE.

The NOMINAL APR is calculated as:

Answer 1

(the rate for a payment period) x (number of payment periods per year)

Question 2

2. How is the EFFECTIVE APR computed?

Answer 2

There are at least THREE WAYS:

1. By compounding the INTEREST RATE for each year, without considering fees.
2. ORIGINATION FEES are added to the balance due, and the total amount is treated as the basis for computing COMPOUND INTEREST.
3. The ORIGINATION FEES are AMORTIZED as a short term loan. This loan is due in the first payment, and the unpaid balance is AMORTIZED as a second long term loan. The extra first payment is dedicated to primarily paying ORIGINATION FEES and INTEREST CHARGES on that portion.

Question 3

3. Consider a 100 loan which must be repaid after one month, plus 5%, plus a 10 fee. If the FEE is NOT considered, this loan has an EFFECTIVE APR of:

Answer 3

approximately 80% (1.05^12 = 1.7959)

Question 4

4. If the $10 fee were added in the calculation of the EFFECTIVE APR, the MONTHLY INTEREST (increases/decreases) by:

Answer 4

10% ($10/$100), and the EFFECTIVE APR becomes +- 435%.
(1.15^12 = 5.3503)
Hence there are at least two possible “EFFECTIVE APR’s”

Question 5

5. In general, APR in the US is expressed as:

Answer 5

the PERIODIC INTEREST RATE times the number of compounding periods in a year. This is known as the NOMINAL INTEREST RATE.