Question

Which of the following statements are most likely to be false?

1. The effective annual interest rate will always be greater than the quoted (or annual percentage) interest rate.
2. All else being the same, the present value of an ordinary annuity will be larger than the present value of an annuity due.
3. If you were borrowing funds from a bank, and the quoted interest rate was 8% p.a., you would be better off if the bank used quarterly compounding rather than daily compounding.

I and II only.

I and III only.

II and III only.

I, II and III.

Answer 1

Effective annual interest rate can be same as the quoted rate if the compounding is annual.

In an ordinary annuity the payments are made at the end of the year but in an annuity due, payments are made at the beginning of the year. Hence, all else being the same, the present value of an ordinary annuity will not be larger than the present value of an annuity due.

Interest rate that are compounded quarterly will require a lower payment than the one's that are compounded daily.

All the statements are false. Hence, the following statements are most likely to be false-

I, II, and III