Question

10-36. Talayna has some money that she wants to put into a savings account and she has two

options. One option pays 2% interest compounded quarterly. Another option pays only 1.5%,

but is compounded monthly. If she wants to deposit the money for 5 years, which account is

better? If she wants to deposit for 25 years, which account is better? Homework Help

Plzzz

Answer 1

Option 1

Explanation:

Effective Interest Rate = [ 1 + ( r / m) ]^ mt - { 1 }

where i = nominal interest rate , n = number of compounding per time period, t = number of time periods

Option 1 : Interest rate 'i' = 2% , Quarterly compounding 'n' = 4 , t = 25 years

EAR = [ 1 + 2% / 4 ]^ (4 x 25) - [ 1 ] = 0.6466 , ie 64.66%

Option 2 : Interest rate 'i' = 2% , Monthly compounding 'n' = 12 , t = 25 years

EAR = [ 1 + 1.5% / 12 ] ^ (12 x 25) - [ 1 ] = 0.4546 , ie 45.46%

As option 1 has higher EAR than option 2, former is better than latter