Question

Assuming all CDs have equal risk, which of the following CD’s investments has the highest effective annual return (EAR)?

		A bank CD that pays 8.78 percent compounded daily
		A bank CD that pays 9.01 percent compounded monthly
		A bank CD that pays 9.10 percent compounded quarterly
		A bank CD that pays 9.17 percent compounded semiannually

Answer 1

1st calculating effective annual rate for all the options using formula

EAR = (1 + APR/n)^n - 1

a), APR = 8.78%, compounded daily

=> n = 365

So, EAR = (1 + 0.0878/365)^365 - 1 = 9.18%

b). APR = 9.01% compounded monthly

=> n = 12

So, EAR = (1 + 0.0901/12)^12 - 1 = 9.39%

c). APR = 9.10% compounded quarterly

=> n = 4

So, EAR = (1 + 0.091/4)^4 - 1 = 9.42%

d). APR = 9.17% compounded semiannually,

=> n = 2

So, EAR = (1 + 0.0917/2)^2 - 1 = 9.38%

So, Option C has highest Effective annual rate.