Question

Your bank account pays a 5% nominal rate of interest. The interest is compounded quarterly. Which of the following statements is CORRECT?

a. The periodic rate of interest is 5% and the effective rate of interest is also 5%.

b. The periodic rate of interest is 1.25% and the effective rate of interest is 2.5%.

c. The periodic rate of interest is 1.25% and the effective rate of interest is greater than 5%.

d. The periodic rate of interest is 5% and the effective rate of interest is greater than 5%.

e. The periodic rate of interest is 2.5% and the effective rate of interest is 5%.

Answer 1

Periodic rate of interest is annual rate of interest divided by number of periods

As Nominal rate is 5% then periodic rate is 1.25%

Effective rate of interest formula is r= (1+i/n)^n-1

where i =0.05

effective rate of interest is 5.0945%

which is more than 5%

OPTION C