What is the 'Annual Equivalent Rate  AER'
The annual equivalent rate (AER) is interest that is calculated under the assumption that any interest paid is combined with the original balance and the next interest payment will be based on the slightly higher account balance. Overall, this means that interest can be compounded several times in a year depending on the number of times that interest payments are made.
BREAKING DOWN 'Annual Equivalent Rate  AER'
In the United Kingdom, the amount of interest received from savings accounts is listed in AER form.The AER is calculated as:
Where:
n = number of times a year that interest is paid
r = gross interest rate
The annual equivalent rate uses the same formula to calculate the amount of interest as the annual percentage yield (APY). The AER indicates the amount of interest that has been earned over a specified period. Contrary to the AER, the equivalent annual rate (EAR) is quoted when borrowing money and gives borrowers an idea of the borrowing costs if the borrower remained overdrawn for one year.
Annual Equivalent Rate Calculation and Interpretation
Similar to the APY, the AER takes into the effects of compounding and measures the amount an account would earn. Moreover, the AER could be used to determine which banks offer better rates and which banks may be attractive investments. Investors should be aware that the annual equivalent rate will typically be higher than the actual annual rate calculated without compounding.
For example, assume an investor wishes to sell all the securities in her investment portfolio and place all her proceeds in a savings account. The investor is deciding between placing her proceeds in either bank A, bank B or bank C, depending on the highest rate offered. Bank A has a quoted interest rate of 3.7% that pays interest on an annual basis. Bank B has a quoted interest rate of 3.65% that pays interest quarterly and Bank C has a quoted interest rate of 3.7% that pays interest semiannually.
Therefore, bank A would have an annual equivalent rate of 3.7%, or ((1 + (0.037) / 1) ^ 1)  1. Bank B has an AER of 3.7%, or ((1 + (0.0365) / 4) ^ 4)  1, which equivalent to that of bank A even though bank B is compounded quarterly. Therefore, the investor would be indifferent between placing her cash in bank A or bank B. On the other hand, bank C has that same interest rate as bank A, but bank C pays interest semiannually. Consequently, bank C has an AER of 3.73%, which is more attractive than the other two banks.

Compound Interest
Compound Interest is interest calculated on the initial principal ... 
Future Value  FV
The value of an asset or cash at a specified date in the future ... 
Interest Rate
The amount charged, expressed as a percentage of principal, by ... 
Discrete Compounding
Discrete compounding refers to the method by which interest is ... 
Bank Rate
The interest rate at which a nation's central bank lends money ... 
Net Interest Margin
A performance metric that examines how successful a firm's investment ...

Personal Finance
APR and APY: Why Your Bank Hopes You Can't Tell The Difference
Banks use these rates to entice borrowers and investors. Find out what you're really getting. 
Personal Finance
How Interest Rates Work on Savings Accounts
Here's what you need to know to grow your rainyday fund. 
Investing
Learn Simple and Compound Interest
Interest is defined as the cost of borrowing money, and depending on how it is calculated, can be classified as simple interest or compound interest. 
Personal Finance
Bank Profitability in the Era of Low Interest Rates
The "lowforlong" policy on interest rates presents a major challenge to bank profitability. 
Investing
4 Ways Simple Interest Is Used In Real Life
Simple interest works in your favor when you're a borrower, but against you when you're an investor. 
Investing
5 Best Ways to Earn Interest
Learn how to use tools to increase your interest earnings. Use compounding interest and breakpoints to increase your interest income. 
Investing
How Negative Interest Rates Can Affect Banks' Bottom Lines
Examine the impacts of low interest rates on banking industry profits and find out if negative interest rates will have a more extreme effect. 
Investing
Analyzing A Bank's Financial Statements
A careful review of a bank's financial statements can help you identify key factors in a potential investment.

What formula can I use to calculate interest on interest?
Find out more about compounding interest, what it measures and how to calculate the amount of compound interest accrued using ... Read Answer >> 
What is the difference between compounding interest and simple interest?
Learn about simple interest and compound interest, how to calculate the two types of interest and the main difference between ... Read Answer >> 
What is the rationale behind the effective interest rate?
Read about the reasons why market actors identify the effective interest rate as it pertains to investing, lending and accounting. Read Answer >> 
What is the difference between stated annual return and effective annual return?
Essentially, the effective annual return accounts for intrayear compounding, and the stated annual return does not. The ... Read Answer >>