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AER Formula:
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The AER (Annual Equivalent Rate) formula converts a gross interest rate to its annual equivalent, accounting for the effect of compounding over multiple periods. It provides a standardized way to compare different financial products with varying compounding frequencies.
The calculator uses the AER formula:
Where:
Explanation: The formula calculates the effective annual rate by considering how interest compounds over multiple periods throughout the year, providing a true representation of annual returns.
Details: AER is crucial for comparing financial products like savings accounts, investments, and loans that compound interest at different frequencies. It allows consumers to make informed decisions by showing the true annual return regardless of compounding schedule.
Tips: Enter the gross interest rate as a percentage and the number of compounding periods per year (e.g., 12 for monthly, 4 for quarterly, 2 for semi-annual). Both values must be positive numbers.
Q1: What's the difference between gross rate and AER?
A: Gross rate is the nominal interest rate without compounding, while AER includes the effect of compounding to show the true annual return.
Q2: How does compounding frequency affect AER?
A: More frequent compounding (higher n) results in a higher AER for the same gross rate, as interest is calculated on previously earned interest more often.
Q3: What are common compounding periods?
A: Common periods include: annually (n=1), semi-annually (n=2), quarterly (n=4), monthly (n=12), and daily (n=365).
Q4: When is AER most useful?
A: AER is most valuable when comparing savings accounts, investments, or loans with different compounding frequencies to determine which offers the best actual return.
Q5: Does AER account for fees or taxes?
A: No, AER only accounts for compounding frequency. It does not include fees, taxes, or other charges that may affect the actual return.