Okay, so let's see, let's go on a little farther, and

see how Know exactly this works.

Let's do two examples.

First one is let's say what's the equivalent annual interest rate of

Bigshark's offer to Mr. Small Net Worth that three quarter mortgage?

Remember was 10% compounded quarterly.

So if we're thinking about it as most people do in annual Terms,

let's see what the equivalent annual interest rate is.

So all we do is apply the formula.

Okay.

So we have for Mr.

Small-Net-Worth the offer on the table is 10% compound ad quarterly.

Okay.

And plugging in the formula four compounding periods four quarters per

year so, we have (1+ 01.1) raised to the 4- 1 = a whopping 46%.

Actually, this in the United States is considered usurious.

And is an illegally high rate, okay?

So by comparison, a more normal and

legal, in the United States, lender might have offered Mr.

Small Or something like this, 10% compounded annually.

What's the equivalent annual interest rate of that?

Well, it's of course (1 + 0.1) raised to the 1.

One yearly compounding period in the year.

This one equals 10%, okay?

So this is a good way to understand what

interest rates are in a time frame that we're all used to.

And it's very good and very necessary to compare projects Under some

circumstances,here is another example where we see how its necessary to compare

projects,so lets say you considering to lend some money in money market and

you have two banks,Bank 1 says will give you 5% compounded annually,Bank

2 says will give you 0.375% per compounded

monthly,which one is better,all we have to convert everything.

To annual too, so we can do apples to apples.

So for Bank 1, the equivalent annual interest rate,

it's already in annual compounding terms, that's 5%.

For Bank 2, we just apply the formula, 1 + r raised to the number of compounding

periods per year, 12 in the case of monthly compounding,- 1 = 4.6%.

So Bank 1 is clearly offering a better deal, but

we have no way of knowing that until we put everything in annual terms.