- CFA Exams
- CFA Level I Exam
- Study Session 2. Quantitative Methods (1)
- Reading 6. The Time Value of Money
- Subject 2. Calculate the Effective Annual Rate

###
**CFA Practice Question**

A money manager has $20 million to invest for one year. She has identified three alternative one-year certificates of deposit (CD) (shown below):

CD1 | Monthly | 7.82%

CD2 | Quarterly | 8.00%

CD3 | Continuously | 7.95%

B. CD 2

C. CD 3

CD | Compounding frequency | Annual interest rate

CD1 | Monthly | 7.82%

CD2 | Quarterly | 8.00%

CD3 | Continuously | 7.95%

Which CD has the highest effective annual rate (EAR)?

A. CD 1

B. CD 2

C. CD 3

Correct Answer: C

CD2: (1 + 0.08/4)

CD3: e

CD1: (1 + 0.0782/12)

^{12}- 1 = 8.1065%CD2: (1 + 0.08/4)

^{4}- 1 = 8.2432%CD3: e

^{0.0795}- 1 = 8.2746%###
**User Contributed Comments**
8

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

fmjohnson7 |
could some just explain how to get the continous EAR using the BAII calculator. |

assiduous |
1) Enter nominal interest rate in decimal format 2) Hit 2nd 3) Hit LN (calculates e^x where x = nominal interest rate) |

birdperson |
for continuous EAR use the formula or the ICONV and then for C/Y enter a big number...that'll get you close enough |

bmalbra |
Hi Guys, Can someone please explain how to get CD3 with financial calculator HP12 C? Thank you |

Huricane74 |
There are two ways to get the answer to C. Method 1: a.) Take .0795 and divide by 365, which gives you 0.000217808 b.) Add 1 to 0.000217808, which give you 1.000217808 c.) Raise 1.000217808 to the 365 power, --> 1.00217808^365 This give you 1.082736187 which is rounded to 8.28% Method 2: a.) On BAII, type 0.0795 b.) Press [2ND] c.) Press e^x This gives you 1.08274556 Method two is more accurate, but method one is close enough if you are only concerned about two decimal points. |

pratik2131 |
to calculate continuous do = 7.95/100=0.0795, then 0.0795 press 2nd and then LN you will get 1.0827 then minus 1 =0.0827^100=8.2746. |

adrianc827 |
@fmjohnson7 honestly i just put 999,999,999 for C/Y and it gets me the correct answer |

Micheal11 |
@adrianc827 same here. I just put a massive number and works just fine. |