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This quiz qestion’s anwer is not clear:
Carter’s treasury department is now considering how to best invest a cash surplus. Investment Exe offers interest of 4% per year, compounded semi-annually, for a period of three years. Investment Wye offers one interest payment of 20% at the end of its four-year life.
Which of the two investments gives the higher annual effective interest rate (work to 2 decimal places)?
Investment Exe annual effective return = 1.022 – 1 = 0.0404 or 4.04%
Investment Wye annual effective return = 41.20 – 1 = 0.0466 or 4.66%
Where do the numbers in 41.20 – 1 = 0.0466 come from?
This is a past Paper MA question (and effective interest rates are explained in our Paper MA free lectures_.
For Exe, the annual effective return is 1.02^2 – 1 = 0.0404 or 4.04%
For Wye, it is the (fourth root of 1.20) – 1 = 0.0466 or 4.66%