Question

Suppose you have several choices for placing your savings in insured bank certificates of deposit. They all pay 5 percent per year – the going interest rate for bank deposits. Most observers expect interest rates to remain at 5 percent for some time to come. One is for 1 year, the second is for 5 years, and the third is for 10 years. Which of the following is the best financial investment?

A

The one-year certificate.

B

The five-year certificate.

C

The 10-year certificate.

D

All are equal as they pay identical interest rates.

Which of the following best describes why?

A

All should have the same interest rates as they are all insured and have the same risk.

B

The shortest maturity certificate of deposit should have the lowest interest rate and the longest maturity should have the highest interest rate.

C

The shortest maturity certificate of deposit should have the highest interest rate and the longest maturity should have the lowest interest rate.

Answer 1

1.

Correct Answer:

A

A longer period investment, should have higher rates, as it attracts more risk. So, it is good to go for the 1 year investment, if there is no any risk premium on investments of longer period.

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2.

Correct Answer:

B

An investment with maturity period of 1 year is giving return that is equal to the return given by 5 year investment period, then it is good to opt for the 1 year investment period.