What is the 'Annual Equivalent Rate - AER'


BREAKING DOWN 'Annual Equivalent Rate - AER'


The AER is calculated as:

Annual Equivalent Rate (AER)

n = number of times a year that interest is paid
r = gross interest rate

The annual equivalent rate uses the same formula to calculate the amount of interest as the annual percentage yield (APY). The AER indicates the amount of interest that has been earned over a specified period. Contrary to the AER, the equivalent annual rate (EAR) is quoted when borrowing money and gives borrowers an idea of the borrowing costs if the borrower remained overdrawn for one year.

Annual Equivalent Rate Calculation and Interpretation

Similar to the APY, the AER takes into the effects of compounding and measures the amount an account would earn. Moreover, the AER could be used to determine which banks offer better rates and which banks may be attractive investments. Investors should be aware that the annual equivalent rate will typically be higher than the actual annual rate calculated without compounding.

For example, assume an investor wishes to sell all the securities in her investment portfolio and place all her proceeds in a savings account. The investor is deciding between placing her proceeds in either bank A, bank B or bank C, depending on the highest rate offered. Bank A has a quoted interest rate of 3.7% that pays interest on an annual basis. Bank B has a quoted interest rate of 3.65% that pays interest quarterly and Bank C has a quoted interest rate of 3.7% that pays interest semi-annually.

Therefore, bank A would have an annual equivalent rate of 3.7%, or ((1 + (0.037) / 1) ^ 1) - 1. Bank B has an AER of 3.7%, or ((1 + (0.0365) / 4) ^ 4) - 1, which equivalent to that of bank A even though bank B is compounded quarterly. Therefore, the investor would be indifferent between placing her cash in bank A or bank B. On the other hand, bank C has that same interest rate as bank A, but bank C pays interest semi-annually. Consequently, bank C has an AER of 3.73%, which is more attractive than the other two banks.

  1. Interest Rate

    Interest rate is the amount charged, expressed as a percentage ...
  2. Effective Annual Interest Rate

    The effective annual interest rate is an investment's annual ...
  3. Compound Interest

    Compound Interest is interest calculated on the initial principal ...
  4. Discrete Compounding

  5. Stated Annual Interest Rate

    A stated annual interest rate is the return on an investment ...
  6. Anticipated Interest

    Anticipated interest is the amount of interest that a savings ...
Related Articles
  1. Personal Finance

    How Interest Rates Work on Savings Accounts

  2. Investing

    Learn simple and compound interest

    Interest is defined as the cost of borrowing money or the rate paid on a deposit to an investor. Interest can be classified as simple interest or compound interest.
  3. Investing

    The Interest Rates: APR, APY And EAR

    When most people shop for financial products, all they focus on is the listed interest rate. Human eyes instinctively dismiss the fine print, which usually includes the terms APR (annual percentage ...
  4. Personal Finance

    Bank Profitability in the Era of Low Interest Rates

    The "low-for-long" policy on interest rates presents a major challenge to bank profitability.
  5. Investing

    How Negative Interest Rates Can Affect Banks' Bottom Lines

  6. Personal Finance

    Simple Interest Loans: Do They Exist?

  7. Investing

    Analyzing a bank's financial statements

    In this article, you'll get an overview of how to analyze a bank's financial statements and the key areas of focus for investors who are looking to invest in bank stocks.
  8. Investing

    4 Ways Simple Interest Is Used In Real Life

  9. Investing

    How Interest Rates Affect Mutual Funds

    Find out how changing interest rates impact mutual funds, including bond and money market funds, and how higher rates can discourage investors.
  1. How to calculate compound loan interest in Excel?

    Find out about compound interest and how to use the compounding interest formula in Microsoft Excel to calculate the compound ... Read Answer >>
  2. How do I calculate compound interest using Excel?

    Learn how to calculate compound interest using three different techniques in Microsoft Excel. Read Answer >>
  3. Yield vs Interest Rate

Hot Definitions
  1. Inflation

  2. Discount Rate

  3. Economies of Scale

  4. Quick Ratio

  5. Leverage

  6. Financial Risk

Trading Center