Question

Suppose you were considering depositing money in a savings account at two different banks. Each bank will pay 5% interest. However, bank A compounds annually and bank B compounds semiannually. Provide a detailed explanation with your investment amount, period of time and your resulting investment. In addition, provide details on how you calculated using Excel (with formula) or financial calculator inputs. Which bank would you choose and why? Be sure to cite your source(s).

Answer 1

Suppose, we have $100,000 to to deposit in saving accounts of Bank A or Bank B for 10 years at interest rate of 5%.

But, Bank A compounds annually and Band B compounds semi-annually.

Compounding means adding principal (initial investment) and interest earned during period to make new principal for next period and in next period interest would be calculated on new principal.

Annual Compounding means bank compound your deposit once in year. And, Semi-annual compounding means bank compound your deposit twice in a year. Thus, FV value of frequent compounding investment is always greater than less frequent compounding investment if others things remains constant.

Please refer to below spreadsheet for calculation and answer. Cell reference also provided.

Cell reference -

Bank-B is better to invest because it has higher Future value due to higher effective annual interest rate.