Question

If a bank uses quarterly compounding for savings accounts, the nominal rate will be greater than the effective annual rate. a. True b. False

Answer 1

b. False

If a bank uses quarterly compounding for saving accounts, the effective annual rate wil be greater than the normal rate as the interest will the effct of compounding will take place four times in a year. For example supplose the nominal rate of interest on saving accounts is 5%. The interest on $1000 saving would be $50 (1000 * 5%). If the interest is compunded quarterly it will be $50.95 (1,000 * (1 + 5%/4)⁴ ) .Hence, the effective rate is 5.095% which is higher than the nominal rate of 5%.