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Bank A pays 2% interest compounded annually on deposits, while Bank B pays 1.75% compounded daily.

a. Based on the EAR (or EFF%), which bank should you use?
b. Could your choice of banks be influenced by the fact that you might want to withdraw your funds during the year as opposed to at the end of the year?Assume that your funds must be left on deposit during an entire compounding period in order to receive any interest.

Respuesta :

Answer:

Bank A

Yes

Explanation:

Effective annual rate = ( 1 + periodic interest rate)^m - 1

periodic interest rate = interest rate / number of compounding per year

m = number of compounding per year

Bank A = (1 + 0.02) - 1  = 2%

Bank B = (1 + 0.0175 / 365)^365 - 1 = 1.7654%

Bank A should be chosen because the EAR is higher

Yes, it should. if one plans to withdraw during the year, Bank B would be a better option because the amount invested would earn interest when withdrawn.

if one plans to withdraw within the year, and he invests in Bank A, if withdrawal is made within the year, all interest would be forfeited.

a. Bank A should be selected.

b. Yes

Calculation of the EAR:

Since we know that

Effective annual rate = ( 1 + periodic interest rate)^m - 1

Here,

periodic interest rate = interest rate / number of compounding per year

m = number of compounding per year

Now

Bank A = (1 + 0.02) - 1  = 2%

Bank B = (1 + 0.0175 / 365)^365 - 1 = 1.7654%

Bank A should be selected since the EAR is higher

b.

Yes, it should. In the case, one plans should be withdrawn at the time of year so here bank B should be a better option since the amount invested earned interest at the time of withdrawn.

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