Question

If $1,000 were invested now at a 12% interest rate compounded annually, what would be the value of the investment in two years

D 30. Your current bank is paying 6.25% simple interest rate. You can move your savings account to Harris Bank that pays 6.25% compounded annually or to First Chicago bank paying 6% compounded semi-annually. To maximize your return you would choose: First Chicago bank Harris Bank your current bank you are indifferent, because the effective interest rate for all three banks is the same

Answer 1

1. Here we will use the following formula:

FV = PV * (1 + r%)ⁿ

where, FV = Future value, PV = Present value = $1000, r = rate of interest = 12%, n= time period = 2

now, putting theses values in the above equation, we get,

FV = $1000 * (1 + 12%)²

FV = $1000 * (1 + 0.12)²

FV = $1000 * (1.12)²

FV = $1000 * 1.2544

FV = $1254.4

So, value of investment after 2 years is $1254.4.

2. Option (a) is correct

Interest is compounded semi annually in First Chicago bank, it means that interest will be compounded 2 times in a year or there will be interest on interest for 2 times in a year. Effective annual rate will be more for First Chicago bank. So returns will be maximum in case of First Chicago bank.