Question

Question 2

2.1a In terms of savings, define the term ‘AER’ and describe how this concept is of use to savers when choosing between different savings products.

2.1b Two standard savings accounts, A and B, have an AER of 3%. Account A pays interest every quarter, and Account B every month. Work out whether the interest paid at the end of the year is higher for Account A, for Account B or the same for both accounts, assuming the same amount was invested in each account initially.

2.2 Briefly explain why a tracker fund offers a lower risk (and potential return) than shares in a single company.

2.3a Franz is looking to save for a £4,000 deposit towards buying a canal boat in 6 years. He has £500 lump sum already and is willing to add another £30 per month. Using the Borrowing and saving calculator, calculate the annual return he would need to seek from a saving product in order to reach his goal.

2.3b Explain which sort of financial product would be suitable for this saving strategy

2.3c Briefly explain another way that Franz could save the amount of his deposit if he is risk-averse or doesn’t have much risk capacity.

Answer 1

2.1a). Annual Equivalent Rate (AER) is the rate used for comparing different savings accounts. So, for example, there are two savings account both paying an APR of 8% p.a. One savings account pays interest compounded every month and another savings account pays interest compounded quarterly then both accounts can be compared using their respective AER. The AER for the account paying interest every month will be [(1+8%/12)^12] -1 = 8.30% whereas the AER for the other account will be [(1+8%/4)^4] -1 = 8.24%. So, the first savings account gives more interest.

2.1b). Since AER for both accounts is same, both accounts will give the same amount of interest at the end of the year, irrespective of the difference in their compounding frequencies.