Question

(Related to Checkpoint 5.7) (Calculating an EAR) Your grandmother asks for your help in choosing a certificate of deposit (CD) from a bank with a one-year maturity and a fixed interest rate. The first certificate of deposit, CD #1, pays 5.45 percent APR compounded semiannually, while the second certificate of deposit, CD #2, pays 5.50 percent APR compounded quarterly. What is the effective annual rate (the EAR) of each CD, and which CD do you recommend to your grandmother? If the first certificate of deposit, CD #1, pays 5.45 percent APR compounded semiannually, the EAR for the deposit is []%. (Round to two decimal places.)

Answer 1

EAR of CD#1 = (1+APR/n)^n - 1

n is the no of compounding i.e. 2

= (1+0.0545/2)^2 - 1

= 5.52%

EAR of CD#1 = (1+APR/n)^n - 1

n is the no of compounding i.e. 4

= (1+0.0550/4)^4 - 1

= 5.61%

CD#2 is recommanded to the grandmother as the EAR of CD#2 is higher than the CD#1 .

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