12. (Related to Checkpoint 5.7) (Calculating an EAR) Your grandmother asks for y

ID: 2794555 • Letter: 1

Question

12. (Related to Checkpoint 5.7) (Calculating an EAR) Your grandmother asks for your help in choosing a certificate of deposit (CD) from a bank with a one-year maturity and a fixed interest rate. The first certificate of deposit, CD #1, pays 3.45 percent APR compounded daily, while the second certificate of deposit. CD #2, pays 3.50 percent APR compounded semiannually. What is the effective annual rate (the EAR) of each CD, and which CD do you recommend to your grandmother? If the first certificate of deposit, CD #1, pays 3.45 percent APR compounded daily, the EAR for the deposit is %. (Round to two decimal places.) If the second certificate of deposit. CD #2, pays 3.50 percent APR compounded semiannually, the EAR for the deposit is %. (Round to two decimal places.) Based on the findings above, which CD do you recommend to your grandmother? (Select the best choice below.) o A. CD #2 that pays 3.50% compounded semiannualy B. CD #1 that pays 3.45% compounded daily

Explanation / Answer

Computation of EAR (effective annual rate) for each deposit:
Formula for EAR = (1+r/m)m-1

CD#1

CD#2

Annual rate

3.45%

3.5%

Compounding

Daily i.e., 365

Semiannual i.e., 2 times

EAR

(1+0.0345/365)365 -1 = 3.51%

(1+0.035/2)2 -1 = 3.53%

Based on the above findings, i will recommend second CD i.e., CD#2 Which gives high return.