EAR = "Effective Annual Rate"
APR = "Annual Percentage Rate"
n = number of periods per year
|Interest rates are usually stated as an APR. This nominal rate of interest is misleading as it does not account for amortization or inflation. The EAR addresses the amortization issue by accounting for compunding.
Example: What is the true cost to a borrower of a mortgage with a 6% APR and monthly amortization?
Answer: [ 1 + (.06 / 12)]^12 - 1 = 6.17%
For further information, see the Equity and Capital Markets class website at FIN 4504.