Let's consider a scenario where a bank issued a loan of USD 80,000 at some point in 2022 and expects to receive USD 17,809.33 in interest and the 80k on October 9, 2023. The Effective Interest Rate (EIR) is, say, 1.85% monthly. When calculating the present value of the expected cash flows at December 31, 2022, two methods are available: using a daily rate or an annual rate, both derived from the monthly rate.

However, a discrepancy arises due to the compounding effect and the chosen method of conversion. The first calculation, employing a daily compounding approach, may yield a slightly different result compared to using an annual rate directly.

To visualize this difference, refer to the graph provided: https://imgur.com/kxdzlLB

Now, considering the potential non-negligible nature of the difference, the question arises: which method should be preferred?



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