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Hello Sir, I have a problem regarding the question below:
An investor has the choice between two investments. Investment Exe offer 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. What is the annual effective interest rate offered by the two investments?
Investment Exe Investment Wye
A. 4.00% , 4.66%
B. 4.00% , 5.00%
C. 4.04% , 4.66%
D. 4.04% , 5.00%For Investment Exe, I’ve been able to get 4.04% as follows:
4% per year, that is 2% semi-annually.
Semi annually = 6months and we have 2 periods of 6months in 1 year.
Therefore, (1+2%)^2 — 1 = 4.04%But I am not able to evaluate for Investment Wye. I am getting answer D when the answer is C.
Sir, could you please clarify for Investment Wye?
Thank you.For Wye, suppose the annual interest rate is R, and they are investing $100.
Then after 4 years, the total owing would be 100 x (1+R)^4
They are getting 20% at the end of 4 years, so the $100 would be 100 x 1.20
Therefore 100 x (1+R)^4 = 100 x 1.20.
(1+R)^4 = 1.20
So 1+R = the fourth root of 1.20 = 1.0466
(I think you can now finish the last step yourself 🙂 )
Yes, will definitely be able to. It is easier when the $100 has been used as example. Got it. Thank you very much Sir.
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