karoliukas

If $1,000 is invested at the beginning of the year at an annual rate of 48%, compounded quarterly, what would that investment be worth at the end of the year?

A) $1,574.

B) $1,048.

C) $4,798.

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N = 1 × 4 = 4; I/Y = 48/4 = 12; PMT = 0; PV = –1,000; CPT → FV = 1,573.52.

karoliukas

In 10 years, what is the value of $100 invested today at an interest rate of 8% per year, compounded monthly?

A) $222.

B) $216.

C) $180.

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N = 10 × 12 = 120; I/Y = 8/12 = 0.666667; PV = –100; PMT = 0; CPT → FV = 221.96.

karoliukas

As the number of compounding periods increases, what is the effect on the EAR? EAR:

A) increases at a decreasing rate.

B) increases at an increasing rate.

C) does not increase.

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There is an upper limit to the EAR as the frequency of compounding increases. In the limit, with continuous compounding the EAR = eAPR –1. Hence, the EAR increases at a decreasing rate.

karoliukas

A local bank advertises that it will pay interest at the rate of 4.5%, compounded monthly, on regular savings accounts. What is the effective rate of interest that the bank is paying on these accounts?

A) 4.59%.

B) 4.65%.

C) 4.50%.

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(1 + 0.045 / 12)12 − 1 = 1.0459 − 1 = 0.0459.

karoliukas

As the number of compounding periods increases, what is the effect on the annual percentage rate (APR) and the effective annual rate (EAR)?

A) APR increases, EAR increases.

B) APR remains the same, EAR increases.

C) APR increases, EAR remains the same.

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The APR remains the same since the APR is computed as (interest per period) × (number of compounding periods in 1 year). As the frequency of compounding increases, the interest rate per period decreases leaving the original APR unchanged. However, the EAR increases with the frequency of compounding.

karoliukas

What is the effective annual rate if the stated rate is 12% compounded quarterly?

A) 57.35%.

B) 12.55%.

C) 12.00%.

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EAR = (1 + 0.12 / 4)4 – 1 = 12.55%

karoliukas

A local loan shark offers 4 for 5 on payday. What it involves is that you borrow $4 from him and repay $5 on the next payday (one week later). What would the stated annual interest rate be on this loan, with weekly compounding? Assuming 52 weeks in one year, what is the effective annual interest rate on this loan? Select the respective answer choices closest to your numbers.

A) 25%; 1,300%.

B) 25%; 300%.

C) 1,300%; 10,947,544%.

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Stated Weekly Rate= 5/4 − 1 = 25%
Stated Annual Rate = 1,300%
Annual Effective Interest Rate = (1 + 0.25)52 − 1 = 109,476.44 − 1 = 10,947,544%

karoliukas

Peter Wallace wants to deposit $10,000 in a bank certificate of deposit (CD). Wallace is considering the following banks:  

• Bank A offers 5.85% annual interest compounded annually.
• Bank B offers 5.75% annual interest rate compounded monthly.
• Bank C offers 5.70% annual interest compounded daily.

Which bank offers the highest effective interest rate and how much?

A) Bank A, 5.85%.

B) Bank C, 5.87%.

C) Bank B, 5.90%.

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Effective interest rates:
Bank A = 5.85 (already annual compounding)
Bank B, nominal = 5.75; C/Y = 12; effective = 5.90
Bank C, nominal = 5.70, C/Y = 365; effective = 5.87
Hence Bank B has the highest effective interest rate.

karoliukas

What’s the effective rate of return on an investment that generates a return of 12%, compounded quarterly?

A) 12.55%.

B) 14.34%.

C) 12.00%.

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(1 + 0.12 / 4)4 − 1 = 1.1255 − 1 = 0.1255.

karoliukas

Use a stated rate of 9% compounded periodically to answer the following three questions. Select the choice that is the closest to the correct answer.The semi-annual effective rate is:

A) 9.00%.

B) 9.20%.

C) 9.31%.

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First, we need to calculate the periodic rate, or 0.09 / 2 = 0.045.
Then, the effective semi-annual rate = (1 + 0.045)2 − 1 = 0.09203, or 9.20%.

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The quarterly effective rate is:

A) 9.40%.

B) 9.00%.

C) 9.31%.

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First, we need to calculate the periodic rate, or 0.09 / 4 = 0.0225.
Then, the effective annual rate = (1 + 0.0225)4 − 1 = 0.09308, or 9.31%.

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The continuously compounded rate is:

A) 9.67%.

B) 9.20%.

C) 9.42%.

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The continuously compounded rate = er − 1 = e0.09 − 1 = 0.09417, or 9.42%.
Calculator Keystrokes for et: Using the TI BA, enter [0.09] [2nd] [ex] (this is the key with LN on the face of the button). On the HP, enter [0.09] [g] [ex] (this key is located in blue on the key with 1/x in white print).