Question

Two banks offer a 10-year CD. Bank A's CD offers 5% yield with monthly compounding; while Bank B's CD offers 4.879% yield with daily compounding. Assume you're considering investing $5,000 in a CD. Which of the following is TRUE? Bank B's CD is preferable since it has a more frequent compounding period. Bank A's CD is preferable since it has a higher yield. At maturity, a $5,000 CD from both banks would be worth the same. At maturity, the CD for Bank A would be worth $8,235.05 At maturity, the CD for Bank B would be worth $8,243.32.

Answer 1

Bank A

EAR = [(1 +stated rate/no. of compounding periods) ^no. of compounding periods - 1]* 100

? = ((1+5/(12*100))^12-1)*100

Effective Annual Rate% = 5.1162

Bank B

EAR = [(1 +stated rate/no. of compounding periods) ^no. of compounding periods - 1]* 100

? = ((1+4.897/(365*100))^365-1)*100

Effective Annual Rate% = 5.0185

Bank As CD is preferable since it has a higher yield.