Question

Which of the following statements is correct, assuming positive interest rates and holding other things constant?

Banks A and B offer the same nominal annual rate of interest, but A pays interest quarterly and B pays monthly. A deposit in Bank B will have a higher value in five years.

Banks A and B offer the same nominal annual rate of interest, but A pays interest daily and B pays semiannually. A deposit in Bank B will have a higher value in five years.

Banks A and B offer the same annual rate of interest, but A pays interest quarterly and B pays semiannually. A deposit in Bank B will have a higher value in five years.

Banks A and B offer the same nominal annual rate of interest, but A pays interest weekly and B pays quarterly. A deposit in Bank B will have a higher value in five years.

Answer 1

Ans- Option 1 is correct. Banks A and B offer the same nominal annual rate of interest, but A pays interest quarterly and B pays monthly. A deposit in Bank B will have a higher value in five years.

- As when Nominal Interest rate and holding period are same, the Investment opportunity one should look for is in which of the opportunities compounding frequency is higher.

Compounding frequency is the no of periods in a year the interest will be compounded like in monthly compounding interest will be compounded 12 times in a year which will increase the Interest income as higher the compounding period higher is interest earned on Interest.

Thus, bank B pays monthly compounding will have a higher future value.