1. What is Effective Annual Rate (EAR)?

The Effective Annual Rate (EAR) is the actual interest rate that an investor earns or pays in a year after accounting for compounding. For bonds, it provides a more accurate measure of return than the simple coupon rate.

2. How Does the Calculator Work?

The calculator uses the EAR formula:

Where:

• \( coupon \) — Nominal coupon rate (as decimal)
• \( periods \) — Number of compounding periods per year

Explanation: The formula accounts for the effect of compounding by raising the periodic rate to the number of compounding periods.

3. Importance of EAR Calculation

Details: EAR allows investors to compare bonds with different compounding frequencies on an equal basis. It's essential for accurate yield comparisons and investment decisions.

4. Using the Calculator

Tips: Enter the coupon rate as a decimal (e.g., 0.05 for 5%) and the number of compounding periods per year (e.g., 2 for semi-annual).

5. Frequently Asked Questions (FAQ)

Q1: What's the difference between EAR and APR?
A: APR doesn't account for compounding, while EAR does. EAR gives the true annual rate when compounding is considered.

Q2: How does compounding frequency affect EAR?
A: More frequent compounding results in a higher EAR for the same nominal rate.

Q3: What's a typical EAR for corporate bonds?
A: Varies widely, but investment-grade bonds typically have EARs between 2-6%, while high-yield bonds may be 6-12% or higher.

Q4: How is EAR used in bond valuation?
A: EAR is used as the discount rate when calculating the present value of future cash flows from a bond.

Q5: Does EAR account for bond premiums/discounts?
A: No, EAR only accounts for the coupon rate and compounding. Yield to maturity (YTM) would be needed for premium/discount bonds.