First Bank is sending alumni of universities an invitation to obtain a credit ca

Question

First Bank is sending alumni of universities an invitation to obtain a credit card, with the name of their university written on it, for a nominal 9. 9% interest per year after 6 months of 0% interest These interest rates apply to the outstanding debt if not paid by a specified date each month, and hence interest is compounded monthly. If you fail to make the minimum payment in any month, your interest rate could increase (without notice) to a nominal 19. 99% per year. Calculate the effective annual interest rates the credit company is charging in both cases Contributed by D. R Loucks, Cornell University

Explanation / Answer

The effective interest rate is calculated as if compounded annually. The effective rate is calculated in the following way, where r is the effective annual rate,  the nominal rate, and n the number of compounding periods per year 

                  r (1+i/n)n -1

 

the effective annual interest rates the credit card company is charging in both cases is 14.54%

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