Suppose People's bank offers to lend you $10,000 for 1 year on a loan contract that calls for you to make interest payments of $250.00 at the end of each quarter and then pay off the principal amount at the end of the year. What is the effective annual rate on the loan?

a. 9.37%

b. 8.46%

c. 10.38%

d. 8.90%

e. 9.86%

c. 10.38%

Explanation:

Loan Amount = $10,000

Quarterly Interest payment = $250

Interest Payment for the year = $250 x 4

Interest Payment for the year = $1,000

Nominal interest rate = ($1,000 / $10,000) x 100 = 10%

Nominal interest rate = r = 10%

Number of periods = m = 4

Effective Interest rate = [ (1 + r/m) ^m]-1

Effective Interest rate = [ (1 + 0.1/4) ^4] -

Effective Interest rate = [ (1 + 0.025) ^4] - 1

Effective Interest rate = 10.38%