Steaks Galore needs to arrange to finance for its expansion program

Question:

Steaks Galore needs to arrange to finance 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 per cent, and the principal must be repaid at the end of the year. A second lender offers 9 per cent, 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%

Show work for points

Answer:

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%

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