Final answer:
The statement that the correct way to annualize an interest rate is to compute the effective annual interest rate is True. Effective annual interest rate includes the impact of compounding, unlike simple interest which only considers the principal.
Step-by-step explanation:
The correct way to annualize an interest rate is to compute the effective annual interest rate. Statement A) is True. The effective annual interest rate takes into consideration the effects of compound interest, as opposed to simple interest which only calculates interest on the principal amount.
To calculate the effective annual interest rate, you need to use the formula (1 + r/n)^n - 1, where r is the nominal interest rate and n is the number of compounding periods in one year. For example, if a bank account has a nominal annual interest rate of 2% that compounds annually, the effective annual interest rate would be 2%. However, if it compounds quarterly, the effective annual rate would be slightly higher due to interest being calculated on interest that has been previously earned throughout the year.
This concept is particularly important in the context of finance and investing where understanding the true cost of borrowing or the actual return on an investment is crucial.