Interest Rate Basics Exercises

Abdulla Javeri

30 years: Financial markets trader

Following Abdulla's video on interest rate fundamentals and simple versus compound interest, this video aims to consolidate that knowledge by working through six simple exercises.

Financial Maths

Following Abdulla's video on interest rate fundamentals and simple versus compound interest, this video aims to consolidate that knowledge by working through six simple exercises.

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Interest Rate Basics Exercises

5 mins 24 secs

Key learning objectives:

What is the periodic rate formula?
What is the EAR formula?
What is the compounding formula?
Which of the following is better for a borrower?

Overview:

Recap on calculation formulae: periodic rate, EAR and compounding.

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Summary

What is the periodic rate formula?

The nominal annual rate divided by frequency; NAR/n

What is the EAR formula?

EAR = (1 + periodic rate)^periods – 1

EAR = e^r*t – 1

What is the compounding formula?

1 + periodic rate^periods

Which of the following is better for a borrower?

Borrowing at 4.30% and paying interest semi-annually or borrowing at 4.20% and paying monthly? Borrowing at 4.30% on a semi-annual basis gives an EAR of 4.346%. Borrowing at 4.20% and paying interest monthly gives an effective rate of 4.282%. A borrower should borrow at 4.20% and pay monthly a depositor should go for the other option as that gives them a higher effective return.

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Abdulla Javeri

Abdulla’s career in the financial markets started in 1990 when he entered the trading floor of the London International Financial Futures Exchange, LIFFE, and qualified as a pit trader in equity and equity index options. In 1996, Abdulla became a trainer for regulatory qualifications and then for non-exam courses, primarily covering all major financial products.

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