Question

Ali has two options to decide where to save his money. He can save his money either at 9% compounded quarterly in bank A or at 8.5 % compounded monthly in bank B. Determine the effective rate for each of the nominal rates offered by the banks.​

Answer 1

Ali would earn more money if he saves his money in bank A as it offers a higher effective annual interest rate.

Bank A: 9.31%

Bank B: 8.81%

Explanation:

The effective annual interest rate is the interest rate that is actually earned or paid on an investment, loan or other financial product due to the result of compounding over a given time period. The formula for calculating the effective annual interest rate is:

(1 + r/n)^n - 1

where r is the nominal interest rate and n is the number of times interest is compounded per year.

For bank A, the nominal interest rate is 9% compounded quarterly. Therefore, the effective annual interest rate would be:

(1 + 0.09/4)^4 - 1 = 9.31%

For bank B, the nominal interest rate is 8.5% compounded monthly. Therefore, the effective annual interest rate would be:

(1 + 0.085/12)^12 - 1 = 8.81%

So, Ali would earn more money if he saves his money in bank A as it offers a higher effective annual interest rate.