Question

Your company is shopping for a bank loan. Three banks (A, B and C) have quoted the following rates:

Bank A: 15 percent, compounded daily;

Bank B: 15.5 percent, compounded quarterly;

Bank C: 16 percent, compounded annually.

Which bank should your company choose to borrow from? Why?

Answer 1

As it is given the annual compounded interest rate of Bank C will be 16 per cent.

However, for Bank A & B we need to calculate the actual effective rate of interest if compounded daily and quarterly.

Suppose the borrowed amount is $1000.

Daily interest rate = 0.04%

Interest amount Bank A = 1000 x ((1 + 0.04)^365) = 1161.80 - 1000 = $161.8

Effective annual interest rate Bank A = 161.8 / 1000 = 16.18%

Quarterly interest rate = 3.88%

Interest amount Bank A = 1000 x ((1 + 3.88)^365) = 1164.24 - 1000 = $164.24

Effective annual interest rate Bank A = 164.24 / 1000 = 16.424%

Hence the annual interest charged for Bank C is the lowest. Interest amount paid is the cost of borrowing. The cost of borrowing is the minimum if loan is taken from Bank C.