Question

2. Using formula: If your credit card says 28% interest compounded monthly, what is the effective interest rate? (4 marks)

Answer 1

To calculate the effective interest rate, we need to take into account the compounding period. In this case, the interest is compounded monthly.

The formula for calculating the effective interest rate is:

Effective Interest Rate = (1 + (nominal interest rate/number of compounding periods))^number of compounding periods - 1

Using this formula, we can calculate the effective interest rate as follows:

Effective Interest Rate = (1 + (0.28/12))^12 - 1
= 0.3068 or 30.68%

Therefore, the effective interest rate for a credit card with a nominal interest rate of 28% compounded monthly is 30.68%.