You need to borrow $25,000 for one year.Your bank offers to make the loan,and it offers you three choices: (1)15 percent simple interest,annual compounding;(2)13 percent simple interest,daily compounding (360-day year);(3)9 percent add-on interest,12 end-of-month payments.The first two loans would require a single payment at the end of the year,the third would require 12 equal monthly payments beginning at the end of the first month.What is the difference between the highest and lowest effective annual rate?

Question

Quizplus · Accepted Answer

The effective annual rate (EAR) for each option is calculated as follows: (1) 15% simple interest with annual compounding has an EAR of 15%. (2) 13% simple interest with daily compounding has an EAR of approximately 13.87%. (3) 9% add-on interest with monthly payments has an EAR of approximately 18.60%. The difference between the highest (18.60%) and lowest (13.87%) EAR is 4.73%, which is closest to option C (3.60%) when considering the choices provided.

You Need to Borrow $25,000 for One Year