Question

Southwestern Bank offers to lend you $50,000 at a nominal rate of 7.2%, compounded monthly. The loan (principal plus interest) must be repaid at the end of the year. Woodburn Bank also offers to lend you the $50,000, but it will charge an annual rate of 9.5%, with no interest due until the end of the year. How much higher or lower is the effective annual rate charged by Woodburn versus the rate charged by Southwestern?

Select the correct answer.

a. 1.46%

b. 1.76%

c. 2.06%

d. 2.66%

e. 2.36%

Answer 1

Effective annual interest rate of Southwestern bank compounded monthly

= (1+0.006)¹²-1

= 7.44%

Annual Interest Rate charged by Woodburn Bank = 9.5%

Lower effective annual interest charged by Southwestern Bank = 9.5% -7.44%

= 2.06%

i.e. C

Note: Monthly interest rate = 7.2%/12

= 0.6%

Compounded monthly