Question

A friend was left $50,000 by his uncle. He has decided to put it into a savings account for the next year or so. He finds there are varying inter- est rates at savings institutions: 23/8% compounded annually, 21/4% compounded quarterly, and 21/8% compounded continuously. He wishes to select the savings institution that will give him the highest return on his money. What interest rate should he select?

Answer 1

Effective interest rate for first option = 2 3/8 % = 2.375%

Nominal interest rate for second option = 2 1/4% = 2.25% compounded quarterly

Effective interest rate for second option = (1 + 0.0225 / 4)^4 - 1

= (1.005625)^4 - 1

= 0.02269 ~ 2.27%

Nominal interest rate for third option = 2 1/8% = 2.125% compounded continously

Effective interest rate for third option = e^0.02125 - 1

= 1.021477 - 1

= 0.021477 ~ 2.15%

As effective interest rate for first option (2.375%) is highest, it should be selected