At one time, commercial banks and savings and loan associations (S&Ls) were restricted in the interest rates they could offer on savings accounts. Under what was known as Regulation Q

Question

At one time, commercial banks and savings and loan associations (S&Ls) were restricted in the interest rates they could offer on savings accounts. Under what was known as Regulation Q, S&Ls were allowed to pay at most 5.5 percent and banks were not allowed to pay more than 5.25 percent (the idea was to give the S&Ls a competitive advantage; it didn’t work). The law did not say how often these rates could be compounded, however.
Under Regulation Q, then, what were the maximum allowed interest rates?

Accepted Answer

The maximum allowed rates occurred with continuous, or instantaneous, compounding.
For the commercial banks, 5.25 percent compounded continuously would be:

EAR=[latex]e^{.0525}-1[/latex]

=[latex]2.71828^{.0525}-1[/latex]

=1.0539026-1

=5.39026%

This is what banks could actually pay. Check for yourself to see that S&Ls could effectively pay 5.65406 percent.

Question 6.11: At one time, commercial banks and savings and loan associati...

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