Question

Suppose that you are considering investing $1,200 in one of the following bank CDs.

•CD 1, which will pay an interest rate of 9 % per year for three years

•CD 2, which will pay an interest rate of 9 % the first year, 7 % the second year, and 6 % the third year

The future value of CD 1 is $ ? and the future value of CD 2 is $ ?

(Round your responses to the nearest cent.)

Given the future values you calculated, which CD should be chosen?

A.CD 1 should be chosen.

B.CD 2 should be chosen.

Now suppose for CD 2 the interest rates stay the same but the order in which they are paid changes such that CD 2 pays an interest rate of

6 % the first year, 7 % the second year, and 9 % the third year. What is the future value of new CD 2?

The future value of new CD 2 is $ ?

(Round your responses to the nearest cent.)

We also have a third CD in which you might invest—one

that pays an interest rate of 4 % the first two years and an interest rate of 10 % the third year.

How does the future value of this investment compare to the other two?

The future value of CD 3 is

▼

greater

less

than the future value of CD 1 and

▼

less

greater

than the future value of CD 2.

Which is the best investment?

The best investment is CD

▼

1

2

3

.

Answer 1

Formula for calculating Future value is

where F = future value

P = present value

r = rate of interest

n= number of years

Calculation of F for CD 1 :

Calculation of F for CD 2 :

As the rates of interest are different every year,

Comparing CD 1 and CD 2, we see that F of CD 1 > F of CD 2

So option 1: CD 1 should be chosen.

If the order of the rates of interest changes from 9%, 7%, 6% to 6%, 7%, 9%, there will be no change in the amount of F of CD 2.- The answer will still be  

Calculation of F for CD 3 :

Now F of CD3 is less than that of CD1

and F of CD3 is also less than that of CD2

Therefore best investment is CD1.