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What does effective annual rate mean?

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effective annual rate
(EAR)
Noun

The annualized nominal rate of interest based on a 365-day year that provides a level yield on a financial instrument to its maturity date or next market-based repricing date equal to the rate that exactly discounts the cash flows to its carrying amount; it is the geometric annualization of the annual percentage rate (APR), including all costs, compounded every interest payment period.

Synonym(s): 
  • annual effective rate (AER); annual effective yield (AEY); annual equivalent rate (AER); effective annual interest rate; effective annual percentage rate; effective annual rate; effective rate.
Comment: 
Its is used to compare financial products that are based on different day-count conventions and calculate compounded interest differently.
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