CFA Practice Question

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CFA Practice Question

A money manager has $20 million to invest for one year. She has identified three alternative one-year certificates of deposit (CD) (shown below):

CD | Compounding frequency | Annual interest rate
CD1 | Monthly | 7.82%
CD2 | Quarterly | 8.00%
CD3 | Continuously | 7.95%

Which CD has the highest effective annual rate (EAR)?

A. CD 1
B. CD 2
C. CD 3
Correct Answer: C

CD1: (1 + 0.0782/12)12 - 1 = 8.1065%
CD2: (1 + 0.08/4)4 - 1 = 8.2432%
CD3: e0.0795 - 1 = 8.2746%

User Contributed Comments 8

User Comment
fmjohnson7 could some just explain how to get the continous EAR using the BAII calculator.
assiduous 1) Enter nominal interest rate in decimal format
2) Hit 2nd
3) Hit LN (calculates e^x where x = nominal interest rate)
birdperson for continuous EAR use the formula or the ICONV and then for C/Y enter a big number...that'll get you close enough
bmalbra Hi Guys,

Can someone please explain how to get CD3 with financial calculator HP12 C? Thank you
Huricane74 There are two ways to get the answer to C.
Method 1:
a.) Take .0795 and divide by 365, which gives you 0.000217808
b.) Add 1 to 0.000217808, which give you 1.000217808
c.) Raise 1.000217808 to the 365 power, --> 1.00217808^365
This give you 1.082736187 which is rounded to 8.28%

Method 2:
a.) On BAII, type 0.0795
b.) Press [2ND]
c.) Press e^x
This gives you 1.08274556

Method two is more accurate, but method one is close enough if you are only concerned about two decimal points.
pratik2131 to calculate continuous do = 7.95/100=0.0795, then 0.0795 press 2nd and then LN you will get 1.0827 then minus 1 =0.0827^100=8.2746.
adrianc827 @fmjohnson7 honestly i just put 999,999,999 for C/Y and it gets me the correct answer
Micheal11 @adrianc827 same here. I just put a massive number and works just fine.
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