Student Question from: David L.
Course:  Fundamentals of Financial Planning – Using the Calculator

Student Question:

Dan – I’m not understanding Question #4. Why is 1 used as the present value? And then why 1 x 12? 

From the Lesson: 

4. Jackie invests her bonus at the beginning of this calendar year. If she earns 7% compounded monthly, what is the annual equivalent rate? Round your answer to two decimal places.

Instructor Response:

Okay – the way we solve this is to essentially grow a dollar and see what the rate of growth was.  So we use 1 as the PV.  The reason we multiply and divide (for the time period) by 12 is because we’ve been asked for monthly compounding, but an answer expressed as an annual rate.  Therefore, we determine monthly rate and multiply by 12 to express as an annual rate.