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In: Finance

Which of the following statements is correct, assuming positive interest rates and holding other things constant?...

Which of the following statements is correct, assuming positive interest rates and holding other things constant? Group of answer choices

Banks A and B offer the same annual rate of interest, but A pays interest quarterly and B pays semiannually. A deposit in Bank A will have a higher value in five years.

Banks A and B offer the same nominal annual rate of interest, but A pays interest weekly and B pays quarterly. A deposit in Bank B will have a higher value in five years.

Banks A and B offer the same nominal annual rate of interest, but A pays interest daily and B pays semiannually. A deposit in Bank B will have a higher value in five years.

Banks A and B offer the same nominal annual rate of interest, but A pays interest quarterly and B pays monthly. A deposit in Bank B will have a higher value in five years.

Solutions

Expert Solution

Assuming positive interest rates and holding other things constant; the corrects statements are –

  • Banks A and B offer the same annual rate of interest, but A pays interest quarterly and B pays semiannually. A deposit in Bank A will have a higher value in five years.
  • Banks A and B offer the same nominal annual rate of interest, but A pays interest quarterly and B pays monthly. A deposit in Bank B will have a higher value in five years.

Explanation:

Holding other things constant, if banks are paying same nominal annual rate of interest; the value of deposit will be higher with the bank which has higher frequency (more number of compounding periods) of interest payments. Because the effective annual rate (EAR) will be more for that bank.

Effective annual rate (EAR) can be calculated with the help of following formula

EAR = (1 + INOM /m) ^m – 1

Where, INOM is nominal annual interest rate per year

And m is the number compounding period per year

jeff jeffy answered 1 day ago
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