Effective annual interest rates are calculated in the two following ways:

1. Effective Rate = Total Interest Paid / Principal Amount

2. Effective Rate = (1 + i / n)^{n} – 1

(Where i is the nominal rate and n is the number of compounding periods per year.)

For example, using the first formula, if the starting principal amount is $1,000 and the total interest paid over the course of the year is $104.70, then the effectiveinterest rate is 10.47%. So, look at the following calculation:

.1047 = 104.7 / 1000

Using the second formula, if the starting principal amount is $1,000, the nominal annual interest rate is 10%, and the rate is compounded monthly, then the effective annual rate is 10.47%. Look at the following calculation:

.1047 = (1 + .10/12)12 – 1

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