526T = £177.60 = Dn 1 +
531 = £100(= D1 ) 1 + + £50(= D2 ) 1 +
534Trying = 10.5 gives £177.353; 10.6 gives £177.624; 10.59 gives £177.596.
535This process of iterative computation yields the AER of 10.59% to two decimal places.
5394. If in the above example there were not an additional deposit contracted in the
540 second year, the calculation is simpler and formula (b) can be used:
543 10(= i ) 11(= i )
546 - 1 100 = 10.498...
547 100 100
550giving an AER of 10.50% to two decimal places.
5545. If an account pays interest more often than once a year, then the AER is
555 calculated by adding each interest payment to the deposit and calculating the
556 next interest payment on the total – compounding the interest.
558The treatment of monthly income accounts shows the basic use of formula (d).
560Suppose a fixed deposit offers two options:
561 A. interest paid annually of 6% per annum
562 B. interest paid monthly at a rate of 5.8% per annum
564Option A will have an AER of 6.00% (see example 1 above).
566For option B, the AER is calculated using formula (d) as:
573 = 1 + - 1 100 = 5.956...
574 12(months per year)100
577giving an AER of 5.96% to two decimal places.
579This demonstrates the value to the depositor of the monthly interest but also shows that the
580two options are not quite identical in terms of return.
5846. A short-term bond, for example an 8-month bond paying 5.5% per annum, has to
585 be treated using a combination of formulae (c) and (d).