 Effective Interest Rates — Practice Questions - dummies

# Effective Interest Rates — Practice Questions

When you borrow money, and the interest is charged more often than annually, this is called compounding. As a result, the effective interest rate will be more than the annual rate.

The following practice questions require you to calculate the effective rate of loans where the interest is compounded quarterly.

## Practice questions

Use the following information to answer the questions.

Travel Fridge, Inc. borrows \$45,000 from the bank for one year at an annual rate of 8% compounded quarterly.

1. How much interest will the company pay on this loan?

2. What is the effective rate of the loan?

1. \$3,709.45

If the interest is compounded quarterly, then interest is charged at the rate of 2% every 3 months. And, the unpaid interest is added to the principal.

First 3 months: in interest is added to the principal.

Second 3 months: in interest is added to the principal.

Third 3 months: in interest is added to the principal.

Fourth 3 months: in interest is due. 2. 8.243%

The effective rate is equal to the interest actually paid divided by the principal. If the interest is compounded quarterly, then interest is charged at the rate of 2% every 3 months. And, the unpaid interest is added to the principal.

First 3 months: in interest is added to the principal.

Second 3 months: in interest is added to the principal.

Third 3 months: in interest is added to the principal.

Fourth 3 months: in interest is due. total interest paid. or 8.243%

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