Question

Bank A pays 3% interest compounded annually on deposits, while Bank B pays 2.25% compounded daily. a. Based on the EAR (or EFF%), which bank should you use?

A. You would choose Bank A because its EAR is higher. You would choose Bank B because its EAR is higher.
B. You would choose Bank A because its nominal interest rate is higher.
C. You would choose Bank B because its nominal interest rate is higher.
D. You are indifferent between the banks and your decision will be based upon which one offers you a gift for opening an account

Answer 1

Answer:

A. You would choose Bank A because its EAR is higher

Explanation:

Bank A pays 3% interest compounded annually on deposits, while Bank B pays 2.25% compounded daily

EAR of Bank A = 3%

EAR of Bank B = (1+2.25%/365)^365 - 1

EAR of Bank B = 2.275% effectively annually

Based on the EAR (or EFF%), which bank should you use?

You would choose Bank A because its EAR is higher.

Answer 2

Answer:

A. You would choose Bank A because its EAR is higher.

Explanation:

The EAR means Effective Annual Rate, and it is calculate by,

$EAR=(1+\frac{\text{Nominal Interest Rate}}{\text{No. of Compounding Periods}} )^\text{No. of Compounding Periods}-1$

The EAR of Bank A = 3%

Thus, EAR of Bank B :

$EAR=(1+\frac{2.25\%}{365} )^{365}-1$

⇒ EAR = 2.3%

Thus, I would choose Bank A because its EAR is higher.