Question

(Related to Checkpoint 5.7) (Calculating an EAR) Your grandmother asks for your help in choosing a certificate of deposit (CD) from a bank with a one-year maturity and a fixed interest rate. The first certificate of deposit, CD #1pays 2.95 percent APR compounded daily, while the second certificate of deposit, CD 12 pays 3.00 percent APR compounded weekly. What is the effective annual rate (the EAR) of each CD, and which CD do you recommend to your grandmother? w the first certificate of deposh, CD #1, pays 2.95 percent APR compounded daily, the EAR for the deposit is % (Round to two decimal places)

Answer 1

Effective rate of interest formula;

= (1+r/m)^n - 1

Where,

r = Annual percentage rate (APR)

m = Number of compounding period in a year

n = Number of compounding periods that rate required for..

Effective rate of Interest of CD#1:

= (1+0.0295/360days)^360days - 1

= 1.000082^360 - 1

= 1.029938 - 1

= 0.029938 or 2.99%

Effective rate of Interest of CD#2:

= (1+0.03/52 weeks)^52weeks - 1

= 1.000577^52 - 1

= 1.030446 - 1

= 0.030446 or 3.045%

Therefore, CD#2 will be selected since deposit rate of CD#2 is higher