Question

Which do you prefer: a bank account that pays 8% per year (EAR) for three years or:

(i) An account that pays 4% every six months for three years?

(ii) An account that pays 12% every 18 months for three years?

(iii) An account that pays 0.8% per month for three years?

Answer 1

Solution:

Suppose $1 is invested in a bank Account that pays 8% per year for 3 Years.

Then after 3 years, amount received will be= (1+r)^n = (1.08)^3= $1.2597

Solution (i):

If $1 is deposited in an account that pays 4% every six months, then amount received after 3 years will be=(1.04)^6= $1.2653.

Therefore in this situation, we will prefer an account that pays 4% every six months.

Solution (ii):

If $1 is deposited in an account that pays 12% every 18 months, then amount received after 3 years will be=(1.12)^2= $1.2544.

Therefore in this situation, we will prefer an account that pays 8% per year.

Solution (iii):

If $1 is deposited in an account that pays 0.8% per month, then amount received after 3 years will be=(1.008)^36= $1.3322.

Therefore in this situation, we will prefer an account that pays 0.8% per month.