Steaks Galore needs to arrange financing for its expansion program. One bank off

Question

Steaks Galore needs to arrange financing for its expansion program.  One bank offers to lend the required $1,000,000 on a loan which requires interest to be paid at the end of each quarter. The quoted rate is 10 percent, and the principal must be repaid at the end of the year.  A second lender offers 9 percent, daily compounding (365-day year), with interest and principal due at the end of the year.  What is the difference in the effective annual rates (EFF%) charged by the two banks?

a. 0.31%

b. 0.53%

c. 0.75%

d. 0.96%

e. 1.25%

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Explanation / Answer

Hi,

Please find the answer as follows:

EAR (Quarterly Compounding) = (1+.10/4)^4 -1 = .1038

EAR (Daily Compounding) = (1+.09/365)^365 -1 = .0941

Difference = .1038 - .0942 = .0096 or .96%

Answer is .96%

Thanks.

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