Question

What would you prefer, a savings account that pays 10% interest compounded semiannually or one that pays 10% interest compounded daily? Explain.

Answer 1

10% interest compounded daily will be preferable

Step-by-step explanation:

In the first case, compounding occurs twice (semiannually)

In the second case, compounded occurs 365 days.

Note that compounding is earning interest on principal plus the already accumulated interest amount.

In the first case the Annual Percentage Rate (APR) would be:

= (1 + 10%/2)^2 - 1

= 0.1025

= 10.25%

In the second case the Annual Percentage Rate APR would be:

= (1 + 10%/365)^365 - 1

= 1.00027397^365 - 1

= 1.105154 - 1

= 0.105154

= 10.51%

So, 10% interest compounded daily will be preferable as it yield more.