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Bank A offers to lend you $1,000,000 at a nominal rate of 6%, compounded monthly. The loan (principal plus interest) must be repaid at the end of the year. Bank B also offers to lend you the $1,000,000, but it will charge 6.40%, with interest due at the end of the year. What is the difference in the effective annual rates charged by the two banks

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Answer:

Bank A:

Real rate= 6.168%

Bank B:

Real rate= 6.4%

Explanation:

Giving the following information:

Bank A:

Annual nominal rate= 6% compounded monthly

Bank B:

Annual rate= 6.4%

The period that we will use to compare is one year.

Bank A:

Nominal rate= 0.06/12= 0.005

Real rate= [(1.005^12) - 1]= 0.06168 = 6.168%

Bank B:

Real rate= 6.4%

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