A local bank is advertising a one year CD at a rate of 5.05% and APY of 5.25%. They state "Interest is compounded daily, calculated on a 365/360 day factor, and can be paid either monthly, quarterly, or at maturity."

I don't understand the 365/360 factor... I thought only compounding frequency and number of days mattered. Is there a way the APY can be 5.25% (we calcuate it as 5.18%) for a one year CD with daily compounding? If someone could help me figure out what I'm missing... I'd be very grateful!

At a simple rate of interest of 5.05%, a 365/360 calculation factor = a daily factor of .014028% compared to a daily factor of .013836% at 365/365.

On a $10,000 one-year CD that compounds daily, that equates to $10517.95 or 5.18% APY using the 365/365 daily factor or $10525.32 or 5.25% APY using the 365/360 daily factor.

And that is why the APY formula starts with the amount of interest to be earned in the term of the deposit. That allows for all of the variations on calculation bases (365/360, 365/365) and compounding (ask an old-timer about "continuous compounding") to get worked out before actually applying the formula. Using 365/360 makes a substantial difference, whether you're charging or paying interest.

The question I have is why the local bank would want to use the 365/360 basis. It makes the nominal rate look worse. That's an advantage when you are talking loan rates, but not when you're trying to sell deposits.

Wow... I didn't know that you could choose a different factor! I thought letting people know that we compounded daily was all that mattered. Thank you everyone... I somehow thought the other bank was erroneously showing a higher APY!

Can anyone tell me, is 365/365 more the norm? And on the OCC calculator, what would I choose to calculate a 365/360 APY?

I don't know the OCC calculator well enough anymore to tell you. But 365/365 (actual days outstanding/actual days in the year) is the norm on deposit accounts. Why you would choose the other, I don't have any idea.