Question

You are considering two ways of financing a spring break vacation. You could put it on your credit card, at 18% APR, compounded monthly, or borrow the money from your parents, who want an interest payment of 6% every six months. Which is the lower rate? (Note: Be careful not to round any intermediate steps less than six decimal places) The effective annual rate for your credit card is % (Round to two decimal places.)

Answer 1

For credit card:

EAR=[(1+APR/m)^m]-1
where m=compounding periods

=[(1+0.18/12)^12]-1

=19.56%(Approx)

For borrowings from parents;

EAR=[(1+0.06)^2]-1

=12.36%

Hence borrowings from parents has lower rate having lower EAR