Question

2. What is the purpose of calculating the effective annual rate? In what situation(s) is it useful? How does the APR differ from the EAR?

3. What is the difference between interest rate risk and reinvestment rate risk? For each, under what conditions is each more of a concern?

Answer 1

2. Effective annual rate is an interest charged annually over a loan taken by the company. It can have different time frames like compounding annually, quarterly, bi-annually, weekly and monthly. This is a benefit to the lender and he's paid the money since he has provided the finance to the company with the terms of interest.The purpose of calculating is to arrive a correct amount of principal and interest on a particular chosen period considering beginning period. We calculate EIR when we have to know the differences of two or more different interest rates charged over the loan or an investment so that we can easily arrive to an investment decision. APR is Annual percentage rate which considers simple interest while EAR considers compounding interest rate.

3. Interest rate risk can be occurred due to unexpected volatility in interest rates which can impact on the fixed income investment. Reinvestment risk rate is when a investor makes a choice to reinvest already invested and redeemed share into the same company but is unable to do so. When interest rates increase , it'll be a burden to the company which pays to the debtors, and this can be concern to the company. When the investor needs to reinvest but loses the opportunity to stay invested or losing the original amount of money could be more of a concern in the reinvestment rate of risk.