Question

bank A's saving account composed of interests once a year, whereas bank B's account compounds interest monthly. Both pay a 1% nominal rate. Which statement below is true?

A) $1 deposited today in bank A will be worth more in one year than $1 deposited in Bank B

B ) $1 deposited today in bank B will be worth more in one year than $1 deposited in Bank A

Answer 1

Statement B is correct as $1 deposited today in Bank B will be worth more in one year than $1 deposited in Bank A since Bank B compounds the interest monthly. Following illustration will show the difference.

FV of $1 deposited today:

Bank A            = 1 * (1+ 1% interest)

                        = 1 * (1+ 0.01)

                        = 1 * 1.01

                        = $1.01

Bank B            = 1 * [1+ (1/12)^12]

                        = 1 * 1.067

                        = $1.067