Question

Monica sees Ross’s credit card bill and notices that he has a balance of $7,650. She wants to try and make Ross see that his credit card company is really imposing a huge drag on his wallet. She starts by pointing out the the card charges a nominal 23.75% rate, but since Ross must make monthly payments, this amounts to monthly compounding. What is the formula for Ross’s effective rate and what should Monica say to Ross to convince him that this credit card is a bad deal for his wallet. (Ross needs to see things laid out on paper with numbers and doesn’t understand APR’s and Effective rates)

Answer 1

EAR = [1 + (Nominal Rate / m)]^m - 1;

m = no. of compounding periods in a year

= [1 + (0.2375/12)]¹² - 1

= 1.2651 - 1 = 0.2651, or 26.51%