2.1.1 Spot the highest Annual Equivalent Rate (AER)
Banks and building societies have to display the Annual Equivalent Rate (AER) offered by each product, to enable investors to make comparisons between savings accounts. The AER takes into account not only how much interest is paid, but also exactly when interest payments to account holders are made.
Activity 2.1 Annual Equivalent Rates
Suppose that a savings account advertises an annual interest rate of 5%, with interest payable either daily, weekly, monthly, quarterly or annually. Which account will have the highest AER?
Discussion
Well done. Daily is the correct answer. The more frequent the payment, the more compounding of interest there will be. Therefore, annual 5% interest paid weekly will have a higher AER than 5% paid monthly, which in turn will have a higher AER than 5% paid quarterly. The table here shows AERs for each period.
Table 2.1
| Advertised rate | 5% | |
|---|---|---|
| Period rate | AER | |
| Daily | 0.0137% | 5.127% |
| Weekly | 0.0962% | 5.125% |
| Monthly | 0.1467% | 5.116% |
| Quarterly | 1.2500% | 5.095% |
| Annually | 5.0000% | 5.000% |
OpenLearn - Managing my investments
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