If M > 1 and you solve the following equation to find i: PV * (1 + (i/M))M*N= FV, the i you get will be
A. the rate per compounding period.
B. the EYE.
C. the TOE.
D. the bond equivalent yield.
E. the EAR.
The answer is A (The rate per compounding period).
While calculating the future value or present value when the compounding is done more than one in a year then the interest rate and number of compounding changes according to the number of compounding.
Let’s understand this from this example,
Suppose in a investment the rate of interest is 10% per year, compounded annually, that means the compounding will be done once a year and the compounding period is also one in a year
Then i = 10%, n = 1
Now let’s suppose the compounding is done half yearly,
That means the M which is compounding period is 2
So the i will become i/M, 10/2 = 5%
Accordingly there are two half year in a single year so n will become 2.