Question

You have $200,000 to invest for a year and have two choices. Bank A pays 8% annually, compounded annually. Bank B pays 8% annually, compounded quarterly. Which bank should you choose and why?

		A. Bank A since its effective annual rate is greater than that of Bank B.
		B. Bank B since its effective annual rate is greater than that of Bank A.
		C. It does not matter since their effective annual rate is the same 8%.
		D. Bank B since its nominal annual rate is greater than that of Bank A.

You want to purchase a new car upon graduation and would like to save up a sum of money for a solid down payment. You have two more years before graduation and you plan to save $150 a month from this month. Your bank will not give you much interest but your parents are so impressed with your financial planning that they will "act as your banker" and agree to grow your money at 12%. How much will you have as your down payment upon graduation?

Answer 1

We need to understand the calculation of effective annual rate to answer the first question:

(1 + EAR)" = (1+ --ynx frequency frequency

r = quoted rate or the nominal rate

0.08 (1 + EARA)' = (1+

So EAR from A is same as r = 8%

0.08 (1 + EARB)' = (1 +

E ARB = 8.24%

So we should choose bank B because EAR is greater. So option B is correct

Q2)We are given the following information:

PMT	$                  150.00
r	12.00%
n	2
frequency	12 (Monthly)

We need to solve the following equation to arrive at the required FV

FV = PMT X (1+ Frequency)"xfrequency – 1 X (1+r/12) frequency (1 + 0.12 2x12 - 1 PV = PMTX x (1 +0.12) FV = 4086.48

So by the end of 2 years, you will have 4086.48 accumulated for down payment