An investment opportunity offered by commercial banks is a certificate of deposi

Question

An investment opportunity offered by commercial banks is a certificate of deposit (CD). One bank formerly advertised a CD as follows: "Four year maturity date, with an interest rate of 7.5%, payable quarterly. Every three months, the CD holder would be paid an amount of 7.5%, times one-fourth of the face value of the CD." which of the following best describes the interest being paid by the CD?

a. compund interest, with i=7.5% per year

b compund interest, with i=1.875% per quarter

c compund interest, with i=7.71% per year

dsimple interest, with i=1.875% per quarter (or 7.5% per year)

Explanation / Answer

Advertisement Period Payment = 1.875% x $100/4 Interest Principal Ending bal 0 $100.00 1 $1.88 $1.88 $0.00 $100.00 2 $1.88 $1.88 $0.00 $100.00 3 $1.88 $1.88 $0.00 $100.00 4 $1.88 $1.88 $0.00 $100.00 $7.50 Total Interest Paid $7.50 a. compund interest, with i=7.5% per year Let Principal be $100.00 Future Value = $100 x (1+7.5%)^1 $107.50 Interest = $107.50 - $100 $7.50 b. compund interest, with i=1.875% per quarter Let Principal be $100.00 Future Value = $100 x (1+1.875%)^4 $107.71 Interest = $107.71 - $100 $7.71 c) compund interest, with i=7.71% per year Let Principal be $100.00 Future Value = $100 x (1+7.71%)^1 $107.71 Interest = $107.71- $100 $7.71 d) simple interest, with i=1.875% per quarter (or 7.5% per year) Interest = $100 x 1.875% x 4 $7.50 Option B and C are the best.

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