Bank One offers a passbook account with a 5.5% annual rate, compounded quarterly.Bank Two offers a money market account at 4.5%, compounded monthly.Find the better growth by calculating the
Effective rates.What is the greater effective rate?
A)4.59%
B)5.61%
C)0.05%
D)0.06%
E)none of the above

Question

Quizplus · Accepted Answer

To find the effective rate, we use the formula:

Effective Rate = (1 + (nominal rate / n))^n - 1

where n is the number of times the interest is compounded per year.

For Bank One:
Nominal rate = 5.5%
n = 4 (compounded quarterly)

Effective Rate = (1 + (0.055 / 4))^4 - 1 = 0.0561 or 5.61%

For Bank Two:
Nominal rate = 4.5%
n = 12 (compounded monthly)

Effective Rate = (1 + (0.045 / 12))^12 - 1 = 0.0459 or 4.59%

Therefore, the effective rate for Bank One is higher than Bank Two. So, the passbook account offered by Bank One is the better choice.

Bank One Offers a Passbook Account with a 5