Effective versus Nominal Interest Rate

Universal Bank pays 4% interest, compounded annually, on time deposits. Regional Bank pays 3%, compounded quarterly.

Based on effective interest rates, in which bank would you prefer to deposit your money?

-Select-Item 1 

I. You are indifferent between the banks and your decision will be based upon which one offers you a gift for opening an account.

II. You would choose Universal Bank because its EAR (or EFF%) is higher.

III. You would choose Regional Bank because its nominal interest rate is higher.

IV. You would choose Universal Bank because its nominal interest rate is higher.

V. You would choose Regional Bank because its EAR (or EFF%) is higher.

Could your choice of banks be influenced by the fact that you might want to withdraw your funds during the year as opposed to at the end of the year? In answering this question, assume that funds must be left on deposit during the entire compounding period in order for you to receive any interest.

-Select-Item 2 

I. If funds must be left on deposit until the end of the compounding period (1 year for Universal Bank and 3 months for Regional Bank), and you think there is a high probability that you will make a withdrawal during the year, then Regional Bank might be preferable.

II. If funds must be left on deposit until the end of the compounding period (3 months for Universal Bank and 1 year for Regional Bank), and you think there is a high probability that you will make a withdrawal during the year, then Regional Bank might be preferable.

III. If funds must be left on deposit until the end of the compounding period (1 year for Universal Bank and 3 months for Regional Bank), and you have no intentions of making a withdrawal during the year, then Regional Bank might be preferable.

IV. If funds must be left on deposit until the end of the compounding period (1 year for Universal Bank and 3 months for Regional Bank), and you think there is a high probability that you will make a withdrawal during the year, then Universal Bank might be preferable.

V. If funds must be left on deposit until the end of the compounding period (3 months for Universal Bank and 1 year for Regional Bank), and you think there is a high probability that you will make a withdrawal during the year, then Universal Bank might be preferable.