Bank A offers a 2-year certificate of deposit (CD)that pays 10 percent compounded annually.Bank B offers a 2-year CD that is compounded semi-annually.The CDs have identical risk.What is the stated,or simple,rate that Bank B would have to offer to make you indifferent between the two investments?
A) 9.67%
B) 9.76%
C) 9.83%
D) 9.87%
E) 9.93%

Question

Quizplus · Accepted Answer

In order to find the effective annual rate of the CD offered by Bank B, we need to use the following formula:

(1 + r/n)^n -1

Where r is the stated annual rate and n is the number of compounding periods per year. Since Bank B compounds semi-annually, we will have:

(1 + r/2)^2 -1 = 0.10

Solving for r, we get:

r = 2[(1+0.10)^(1/2)] - 2 = 0.0976 or 9.76%

Therefore, Bank B would have to offer a stated rate of 9.76% to make you indifferent between the two investments.

Bank a Offers a 2-Year Certificate of Deposit (CD)that Pays