Identify whether the following statements about the simple and compound interest

Question

Identify whether the following statements about the simple and compound interest methods are true or false Statement True False The process of earning compound interest allows a depositor or investor to earn interest on any interest earned in prior periods After the end of the second year and all other factors remaining equal, a future value based on compound interest will never exceed the future value based on simple interest. All other factors being equal, both the simple interest and the compound interest methods will accrue the same amount of earned interest by the end of the first year. O Dimitri is willing to invest $45,000 for six years, and is an economically rational investor. He has identified three investment alternatives (A, B, and C) that vary in their method of calculating interest and in the annual interest rate offered. Since he can only make one investment during the six-year investment period, complete the following table and indicate whether Dimitri should invest in each of the investments. Note: When calculating each investment's future value, assume that all interest is earned annually. The final value should be rounded to the nearest whole dollar Make this investment? Investment Interest Rate and MethodExpected Future Value Yes No 10% simple interest 6% compound interest 7% compound interest

Explanation / Answer

First of all, the only difference between Simple Interest and Compound Interest is that interest is earned on interest under compound interest while no interest is earned on interest in Simple Interest Method

1.True, Interest on Interest earned in Compounding

2.False, It Will always exceed, since interest on interest component will be extra under compound interest

3.True, since there is no prior interest component in the first year

Amount Available = $45000

Time Period = 6 years

He should invest in the option in which he gets maximum future value

Investment A: Future Value = 45000 + 45000*10%*6 = $72000

Investment B: Future Value = 45000(1+0.6)6 = $63,833

Investment C: Future Value = 45000(1+0.7)6 = $67,533

Hence, Invest In A and Not in B and C

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