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Dear Open Tuition,
I wonder if you could illustrate the working for below question: (I got investment P correct but have no idea about Q).
Two investments are available. Investment P offers interest of 5% per year compounded half-yearly for a period of 4 years. Investment Q offers one interest payment of 18% at the end of its 4 year life.
What is the annual effective interest rate offered by each of the two investments? (Answer is P: 5.06%, Q: 4.22%.)
Thanks in advance.
P: the interest is 2.5% every six months.
So annual effective interest = (1.025)^2 – 1 = 0.0506 (5.06%)Q: if the annual rate were r, then the total over 4 years would be (1+r)^4 – 1, and this must equal 0.18.
So…….(1+r)^4 = 1.18; 1+r = 4th root of 1.18 = 1.0422
r = 0.0422 (4.33%)
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