Mark plans to invest $500 in a GIC for 2 years. He has a choice of 2 plans: Plan A: 6.75% compounded annually Plan B: 6.60% compounded quarterly. In which plan should Mark invest? Explain.

Answer 1

Compounded annually means, you are paid interest at the end of each year. So, at 6.75%, at the end of the year, you will get,

$500*6.75/100 = $33.75 interest

Compounded quarterly, you are paid at the end of each quarter, 1/4 of the annual interest. So, at the end of first quarter:

Q1: $500*6.60/100/4=$8.25 interest.

Now, you have $508.25 principle to earn your second quarterly interest.

Q2: $508.25*6.60/100/4=$8.39 interest

Let's do the same for the rest of the quarters:

Q3: $516.64*6.60/100/4=$8.52 interest

Q4: $525.16*6.60/100/4=$8.67 interest

At the end of the year, you will have $533.83, which means a compounded interest of $33.83. Mark should invest in Plan B.

There is another way to tackle this problem. To calculate the total of principle and interest, use (1+r/100), where r is the interest rate on percentage. So,

Q1: $500*(1+6.60/100/4) = $508.25

To get the quarterly compounded interest, use this formula,

$500*(1+6.60/100/4)⁴=$533.83

Let me know if you want to learn more about this formula and how we can drive it.