A NOW account requires a minimum monthly balance of $500 if annual interest of 5 percent is to be earned monthly on its deposits. An account holder has maintained an average balance of $300 for the first nine months of the year and $800 for the last three months of the year. She has written an average of 20 checks a month and is not charged for these services. However, it costs the bank $0.02 to process each check.
-What is the average return (both explicit and implicit) earned by the account holder if the bank pays interest on only the amounts in excess of the required minimum of $200?
A)2.01 percent.
B)2.65 percent.
C)3.78 percent.
D)5.35 percent.
E)6.13 percent.

Question

Quizplus · Accepted Answer

The account holder earns interest on the excess balance over $200. For the first nine months, the excess balance is $100 ($300 - $200), and for the last three months, it is $600 ($800 - $200). The interest earned is calculated monthly at 5% annually, which is approximately 0.4167% per month. The implicit return from free check processing is $0.40 per month (20 checks x $0.02). Calculating the total explicit and implicit returns over the year and dividing by the average balance gives an average return of approximately 3.78%.

A NOW Account Requires a Minimum Monthly Balance of $500