Question

Bank A offers to lend you $100,000 at a nominal rate of 6%, compounded monthly. The loan (principal plus interest) must be repaid at the end of the year. Bank B also offers to lend you the $100,000, but it will charge 6.40%, with interest due at the end of the year. What is the difference in the effective annual rates charged by the two banks

Answer 1

Answer:

0.30 % is the correct option

Explanation:

According to the given information,

Nominal return for Riverside = 6.5%

Nominal return for Midwest = 7.0%

Periods for Riverside = 12

Periods for Midwest = 1

This problem can be worked using the conversion formula. The formula is shown below:

Effective interest rate (Riverside) = {[1+ (rnom / N)]^N} - 1

                                                  = {[ 1 + (0.065 / 12)]^ 12}- 1)

                                                  = {[ 1 + 0.00542] ^ 12} - 1

                                                  = 1.0670 - 1

                                                  = 0.067 or 6.7%

Therefore, the effective interest rate is 6.7% for Riverside

But the effective interest rate for Mid west is 7.0%

The difference is (7.0% - 6.7%) = 0.3%

Therefore, the correct option is d) 0.30%