- CFA Exams
- CFA Level I Exam
- Study Session 2. Quantitative Methods (1)
- Reading 6. The Time Value of Money
- Subject 4. The Future Value and Present Value of a Series of Equal Cash Flows (Ordinary Annuities, Annuity Dues, and Perpetuities)

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**CFA Practice Question**

An investment pays $2,500 per month at the beginning of each month and will continue to do so for five years. What is the effective annual rate on this investment if the investment costs $130,000 today?

A. 6.0%

B. 6.2%

C. 6.5%

**Explanation:**Set the calculator in the BGN mode, as this is an annuity due. Calculate monthly interest rate:

PMT = 2,500; PV = -130,000; N = 60; CPT I/Y = 0.5%

EAR = (1 + 0.5/100)

^{12}- 1 = 0.061678 or 6.2%

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**User Contributed Comments**
19

User |
Comment |
---|---|

linr0002 |
The I/Y computed is 0.4816846 instead and not 0.5%. This gives a more exact ans of 5.9358% for the effective rate. This seems to be the more correct ans. |

sonderfall |
I don't think so "linr0002" because the payment is at the beginning = 0.4989% |

ohwos |
sonderfall is right |

FCFA |
Is there a way to calculate EAR on BAII? |

cswin |
need to convert I/Y to EAR |

coolnan |
sonderfall is right as this is annuity due problem. should use BGN mode |

AndyBear |
EAR = (1 + .5/100)12 - 1 = 0.061678 or 6.2% Why divide by 100? |

samerthehammer |
Please explain how you got the EAR calculation the ^12 is to get the monthly but what is the 100 for. |

Allen88 |
the 100 is to convert the .5% to a decimal form. |

tw46605 |
how do you use the BGN function? |

rayrlee |
on a HP 12c, g then 8 to convert to BGN |

vampiremeg |
why is it divided by 100 instead of 12? |

Sanghamitra |
how to convert to bgn in txs II? |

Sanghamitra |
@andy - divide by 100 because the I/Y is in percentage terms - .5%. so u make it .5/100 |

prtwf |
um... what's wrong with my BA II? i did the calculation in bgn mode and still got -0.479 as I/Y... help... |

jorgeman81 |
same here prtwf! |

lordcomas |
I also got the wrong answe even if I set it as Begin mode. |

kingdave |
here we have the number of years which is five. I don't understand where discounting rate of 0.5% is coming from. can you please explain. |

bemccall95 |
@Everyone Set your calculator to BGN mode, then enter the following things: N= 60 PV= -130,000 PMT= 2,500 FV= 0 Solve for I/Y, then divide this by 100 to get it in decimal form, then add 1 and you should have 1.005. Then do (1.005^12) - 1 and you should get something like 6.15%, which they round up to 6.2%. |