Question

Question: Your Nick company needs to borrow funds and has several options available to it, Loans A, B and C. The interest rates (APR) for these options are given below. What is the EAR of the loan option the company should choose?  

Loan A: 4.26% APR, (compounded semi-annually

Loan B: 4.25% APR, (compounded quarterly)

Loan C: 4.24% APR, (Compounded daily, assume 365 days in a year)

EAR of Loan A: 4.31%

EAR of Loan B: 4.32%

EAR of Loan C: 4.33%

Which loan should be taken AND why?

Answer 1

Nick Company wants to borrow funds and following options are avilable:

Loan A : APR 4.26%, EAR 4.31%

Loan B: APR 4.25%, EAR 4.32%

Loan C: APR 4.24%, EAR 4.33

Effective Annual Rate (EAR) takes into account the effect of compounding, it is that rate that is actually paid on borrowed funds as a result of compounding. More is the compounding higher is the EAR, In this case Loan C is compounded daily therefore higher will be EAR i.e. 4.33% besides its Annual percentage rate (APR) is 4.24%.Therefore that loan will be taken whose EAR is least, In this case Loan A should be taken having EAR of 4.31% besides having APR of 4.26% which is highest of loans because it is compounded annually others are compunded quarterly and Daily.