Suppose you are considering taking consumer loan from bank for one year. Usually, for short- term...

Suppose you are considering taking consumer loan from bank for one year. Usually, for short- term loans, the bank offers 8 percent interest that compounds annually. Your credit application has been viewed by a few banks and two of them replied; Bank ALFA offers you a loan at 8 percent annual rate-interest payment by the end of year, and Bank BETA offers a loan with the same annual interest rate, but interest payment is 2 percent by the end of each quarter. Which loan do you prefer? Why?

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Expert Solution

EAR for Bank Alpha = 8%

EAR for Bank Beta

EAR = (1 + APR / m) ^ m -1

EAR = (1 + 8% / 4) ^ 4 -1

EAR = 8.24%

As per above calculations we can see that in case of Bank Beta you will end up paying higher effective annual rate (EAR) which is 8.24%. So as you are at borrowing side you will prefer to pay less EAR hence you will chose bank Alpha.

jeff jeffy answered 2 years ago

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