There are many factors influencing the cost of money for both individuals and co

Question

There are many factors influencing the cost of money for both individuals and corporations. Suppose you deposit money in an interest-bearing account and at the same time borrow a bit of money from the same bank.

1. In which account would the bank apply quarterly compounding factors versus simple interest? Define with a reference and explain. (In the U.S.

2. Explain your choices and your reasoning. You may want to check your personal accounts in regard to this type of transaction. (In the U.S.)

3. PLEASE LIST REFERENCES TO WHERE I CAN LOOK IT UP AND IN-TEXT CITATIONS SO I CAN GO OFF THAT

THERE IS NO INTEREST RATE. THESE ARE JUST QUESTIONS

Explanation / Answer

Let’s say you deposit money in an interest bearing account, such as savings account, fixed deposit account or recurring deposit account, this account would earn quarterly compound interest. For savings account interest is calculated on daily basis and credited to account quarterly at annual rate.

According to handsonbanking.org, "If account pays compound interest, that means the bank will pay you interest not only on your original deposit but also on the interest your deposit has earned over time. With compound interest, your money grows more and a lot faster".

Interest is often compounded monthly, quarterly, semiannually or annually. With continuous compounding, any interest earned immediately begins earning interest on itself.

For example if an account had $500 dollars and at the end of the quarter it had $10 earned in interest the following quarter it would earn interest on $510 as opposed to the original $500. Over time this would generate a much larger amount on interest earned then simple interest would.

On the other side, Individuals borrow money from banks for buying vehicle, for personal use, for buying home etc. and corporations borrow money for funding projects and expand their business operations.

In terms of borrowed money, the interest rate is typically applied to the principal, which is the amount of money lent. The interest rate is the cost of debt for the borrower and the rate of return for the lender.

For these kinds of accounts, bank generally applies simple interest. Simple interest is called simple because it ignores the effects of compounding. The interest charge is always based on the original principal, so interest on interest is not included.

For example, if you take a vehicle loan of $10,000 from bank at 5% simple interest rate annually. Then, you have to pay $500 as simple interest amount.

Reason to apply compound interest on deposits and simple interest on loans:

Banks provide various loans and advances to industries, corporates and individuals. The interest received on these loans is their main source of income. So, to attract more customers/borrowers banks generally apply simple interest. If borrowers serve interest after due date, then compound interest is recovered from borrowers.

Banks apply compound interest on deposits as compound interest deposits provide more return to depositors.

As bank’s main function is to receive money from depositors and provide loans to borrowers. Compound interest deposits will attract depositors to deposit more savings with banks.

Related Questions

Navigate

• Browse (All)
• Browse T
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.