Question

2. PWC recently proposed to BMO to change the method of compounding interest on line of credit accounts to monthly compounding, as part of the marketing campaign. If the current rate is 2.5% compounded quarterly, what nominal rate should the PWC suggest to BMO executives to maintain the same effective rate of interest?

Answer 1

Current rate is 2.5% compounded quarterly

So it means $100 today will have a value of $102.5 after 3 month.

Now, PWC recently proposed to BMO to change the method of compounding interest on line of credit accounts to monthly compounding, as part of the marketing campaign.

So we have to derive the monthly compounding interest rate in such a way that after 3 month the value of 100 will be 102.5.

Hence, 102.5 = 100*(1+x)^3

1.025 = (1+x)^3

Accordingly, x = 0.8%.

It means the monthly compunding rate is 0.8% which will equivalent to 2.5% per quarter.