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?
-Select-IIIIIIIVVItem 1
b. Could your choice of banks be influenced by the fact that you might want to withdraw your funds during the year as opposed to at the end of the year? Assume that your funds must be left on deposit during an entire compounding period in order to receive any interest.
-Select-IIIIIIIVV
SOLUTION:-
EAR=(1+r/m)^m-1 where m is compounding periods per year
(a)
EAR of Bank A=(1+3%/1)^1-1=3.000%
EAR of Bank B=(1+2.25%/365)^365-1=2.275%
You would choose Bank A because its EAR is higher.
(b)
If funds must be left on deposit until the end of the compounding
period (1 year for Bank A and 1 day for Bank B), and you think
there is a high probability that you will make a withdrawal during
the year, then Bank B might be preferable.
Bank A pays 3% interest compounded annually on deposits, while Bank B pays 2.25% compounded daily....
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