Determine the effective annual yield for each investment. Then select the better investment.
5.06% compounded monthly; 5.07% compounded annually
To determine the effective annual yield for each investment, we can use the formula:
Effective Annual Yield = (1 + (nominal interest rate / number of compounding periods))^number of compounding periods - 1
For the first investment, with a nominal interest rate of 5.06% compounded monthly, we have:
Effective Annual Yield = (1 + (0.0506 / 12))^12 - 1
= (1.0042167)^12 - 1
≈ 0.0512 or 5.12%
For the second investment, with a nominal interest rate of 5.07% compounded annually, we have:
Effective Annual Yield = (1 + (0.0507 / 1))^1 - 1
= (1.0507)^1 - 1
≈ 0.0507 or 5.07%
Comparing the two effective annual yields, we can see that the first investment has an effective annual yield of approximately 5.12%, while the second investment has an effective annual yield of approximately 5.07%. Therefore, the first investment with a 5.06% nominal interest rate compounded monthly is the better investment.