Suppose you invest $10,000 in a savings account earning 2% interest (compounded

Question

Suppose you invest $10,000 in a savings account earning 2% interest (compounded yearly) with no risk. After 7 years, how much will you have?

Repeat Question #1, but this time there is an inflation rate of 4%. How does this change your overall return on investment? If you had a chance to invest in an account with a long-term expected rate of 5%, with a 50% chance of earning 0% nominal compound interest and a 50% chance of earning 10% nominal compound interest in each year, would you choose this account, or the savings account? Why?

Explanation / Answer

Overall return on investment will decrease by 1270.93 = 10000 - 8729.07

Would choose the account with the 5% expected rate of return because it has higher effective annual return over the saving account.

Principal $             10,000.00 Rate 2.00% Year 7 Amount (Compound interest) = P x (1 + r/n)^nt Where P = Principal
r rate of interest
n = number of time interest is calculated in a year
t is time Amount after 7 years = 10,000 x (1+..07/1)^7 $             11,486.86

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