math questions financial

Question

Determine the effective annual yield to the nearest tenth of a percent for each Investment.  Then select the best Investment. 

 

A. 5% compounded monthly 

 

B.  5.1 % compounded quaterly 

 

Answer 1

The formula for compound interest is:

 

A = P(1 + r/n)^nt

 

where:

• A = the final amount of the investment
• P = the initial amount (principle)
• r = annual interest rate expressed as a decimal
• n = number of compoundings per year
• t = time = 1 year

 

a)   A = P(1 + 0.05/12)12 = P(1.0042)¹² = 1.0512*P

      The effective annual yield is 0.0512 = 5.12%

 

b)  A = P(1 + 0.051/4)4 = P(1.01275)4 = 1.0519*P

     The effective annual yield (rate) is 0.0519 = 5.19%

     So this is the better investment