Judith Bao is a registered nurse who earns $3,250 per month after taxes. She has
ID: 2383354 • Letter: J
Question
Judith Bao is a registered nurse who earns $3,250 per month after taxes. She has been reviewing her savings strategies and current banking arrangements to determine if she should make any changes. Judith has a regular checking account that charges her a flat fee per month, writes an average of 18 checks a month, and carries an average balance of $795 (although it has fallen below $750 during
3 months of the past year). Her only other account is a money market deposit account with a balance of $4,250. She tries to make regular monthly deposits of $50-$100 into her money market account but has done so only about every other month.
Of the many checking accounts Judith's bank offers here are the three that best suit her needs.
* Regular checking, per-item plan: Service charge of $3 per month plus 35 cents per check.
* Regular checking flat-fee plan (the one Judith currently has): Monthly fee of $7 regardless of how many checks written. With either of these regular checking accounts, she can avoid any charges by keeping a minimum daily balance of $750.
* Interest checking: Monthly service charge of $7; interest of 3 percent compounded daily (refer to Exhibit 4.8). With a minimum balance of $1,500, the monthly charge is waived.
Judith’s bank also offers COS for a minimum deposit of $500 the current annual interest rates are 3.5 percent for 6 months, 3.75 percent for 1 year and 4 percent for 2 Years.
Critical Thinking Questions:
1 Calculate the annual cost of each of the three accounts, assuming that Judith's banking habits remain the same. Which plan would you recommend and why?
2. Should Judith consider opening the interest checking account and increasing her minimum balance to at least $1,500 to avoid service charges? Explain your answer.
3. What other advice would you give Judith about her checking account and savings strategy?
Explanation / Answer
Answer:
Annual cost of each of the three accounts:
Assuming that judith's banking habit remains same, and will not able to maintain a daily balance(not monthly) of $750 through out the year.
1.Regular checking, per-item plan: Annual service charge+ Total annual Check fees = 12*$3+18*12*$0.35 = $111.6
2. Regular checking flat-fee plan: Annual service charge = 12*$7 = $84
3.Interest checking account:Annual sevice charge - Interest on usual balance maintained
= 12*$7 - {$750*(1+0.03/365)365 -$750}= $84-22.84 = $61.16
It is recommended to use the 3rd account, because of lowest annual cost.
2. If the minimum balance is incresed to $1,500 under interest checking account then the annual cost will be:
Annual service charge + Net opportunity cost of Interest on deposit(i.e.cost of not depositing with COS @3.75% for 1 year.
= 0+{$1,500*3.75% - {$1500*(1+0.03/365)365 -$1,500} = 56.52--45.68 = $10.84
So under this option the cost is the lowest.Hence judith should certainly consider this option.
3. if Judith seriously considers to lower his annual cost then the third option of the interest checking account is the best one. But for this he should spend conservatively to maintain the minimum balance.
But if he is not able take the route above then with a little conscious effort he would be able to maintain minimum daily balance of $750 on his account under option 1 & 2, to save on signifiacant annual charges.
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