Homework Answers
The cash flows are annual but the compounding of interest rate is quarterly therefore effective annual rate (EAR) will be used in the given equation
For compounded quarterly -
Effective annual rate (EAR) = (1 + APR/m) ^m – 1
Where,
Effective annual rate (EAR); i =?
And annual percentage rate APR = 6%
Number of compounding period per year = 4 (for quarterly compounding)
Therefore
i = (1+ APR/4) ^ 4 -1
Or i = (1+ 6%/4) ^ 4 – 1 = (1 + 0.015) ^4 -1
Or i = = 1.06136 -1 = 0.06136 or 6.136%
Therefore correct answer is option c) 6.136% (effective rate)
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