Question

You are given the opportunity to put your money in one of two savings accounts. Account 1 compounds interest monthly at a rate of 0.4%. Account 2 compounds every year at a rate of 4.8%. Which account would you choose and why?

a) Account 1, because it offers higher compounding frequency.
b) Account 2, because it offers a higher annual interest rate.
c) Account 1, because it offers a higher overall return.
d) Account 2, because it offers more long-term stability.

Answer 1

Account 2 would be the better choice because it offers a higher overall return. Hence, the correct answer is option (b).

Step-by-step explanation:

To determine which savings account to choose, we need to compare the compounding frequency and the interest rate of both accounts. In this case, Account 1 compounds interest monthly at a rate of 0.4%, while Account 2 compounds interest annually at a rate of 4.8%.

Account 1: After one year, the account balance would be:

Principal amount = $100

Interest rate = 0.4% = 0.004

Number of times interest compounds = 12 (monthly compounding)

Account balance at the end of the year = $100(1 + 0.004/12)^12 ≈ $100.40

Account 2: After one year, the account balance would be:

Principal amount = $100

Interest rate = 4.8% = 0.048

Number of times interest compounds = 1 (annual compounding)

Account balance at the end of the year = $100(1 + 0.048) ≈ $104.80

Based on these calculations, Account 2 would be the better choice because it offers a higher overall return.