Universal Bank pays 7% interest, compounded annually, on time deposits. Regional

Question

Universal Bank pays 7% interest, compounded annually, on time deposits. Regional Bank

pays 6% interest, compounded quarterly.

          a. Based on effective interest rates, in which bank would you prefer to deposit your money?

          b. Could your choice of banks be influenced by the fact that you might want to

               withdraw your funds during the year as opposed to at the end of the year? In

               answering this question, assume that funds must be left on deposit during an entire

               compounding period in order for you to receive any interest.

Explanation / Answer

a) EAR = (1+r/m)^m - 1

Universal Bank ( m = 1 ) EAR = 7%

Regional Bank (m = 4 ) EAR = [ ( 1 + 0.06/4)^4 ] - 1 = 0.06136 = 6.13%

Universal Bank provides better rate

b) In case of Universal Bank you cannot earn interest on your accrued interest until 0ne year whereas in case of Regional bank you earn interest on accrued interest every quarter.Hence quarterly compounding ( Regional Bank ) is better if one withdraws money during the year.

Related Questions

Navigate

• Browse (All)
• Browse U
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.