Question

Savings account A and savings account B both offer APRs of 5%, but savings account A compounds interest annually, while savings account B compounds interest monthly. Which savings account offers the higher APY?

Answer 1

Account B will yield more.

Explanation:

Savings account A and savings account B both offer APRs of 5%

But savings account A compounds interest annually, while savings account B compounds interest monthly.

Lets check which account will yield more :

Account A.

Lets take p = 10,000

r = 5% or 0.05

n = 1

t = 1

Compound interest formula is :

`p(1+(r)/(n))^(nt)`

Substituting values in formula;

`10000(1+(0.05)/(1))^(1)`

= $10500

Account B:

Lets take p = 10,000

r = 5% or 0.05

n = 12

t = 1

Compound interest formula is :

`p(1+(r)/(n))^(nt)`

Substituting values in formula;

`10000(1+(0.05)/(12))^(12)`

= $10510

We can see that account B gives more yield as compared to account A. When an account is compounded monthly, we earn interest on interest. This is why we yield more.

Therefore, account B will yield more.

Answer 2

Account B

Explanation:

When compounding interests monthly that means that there will be 12 times a year that the interests will be compounded, while in the other option the interests will only be compounded one time a year. Since that is the case, the one that will produce more interests for the person opening that account would be B since the interests are compounded annually.