Gomez Electronics needs to arrange financing for its expansion program.Bank A offers to lend Gomez the required funds on a loan where interest must be paid monthly,and the quoted rate is 8 percent.Bank B will charge 9 percent,with interest due at the end of the year.What is the difference in the effective annual rates charged by the two banks?
A) 0.25%
B) 0.50%
C) 0.70%
D) 1.00%
E) 1.25%

Question

Quizplus · Accepted Answer

The effective annual rate (EAR) for Bank A is calculated using the formula: EAR = (1 + i/n)^(n*t) - 1, where i is the nominal rate, n is the number of compounding periods per year, and t is the number of years. For Bank A, EAR = (1 + 0.08/12)^(12*1) - 1 ≈ 8.30%. For Bank B, the EAR is simply the nominal rate since interest is compounded annually, so EAR = 9%. The difference in EARs is 9% - 8.30% = 0.70%.

Gomez Electronics Needs to Arrange Financing for Its Expansion Program