Personal Savings and Consumer Credit: Part Two — Test
Question 7 • Advanced Financial Algebra
Grant is considering two investment opportunities: 1. a bond fund with an annual interest rate of 5% , compounded semiannually 2. a money market fund with an annual interest rate of 4.9% , compounded monthly Evaluate the financial data for a one-year period. Which statement is true about the effect of the compounding periods on the total interest earned?
Answer
A
The money market fund will yield a higher amount due to its more frequent compounding, despite its slightly lower interest rate.
B
Both investment options will yield the same amount at the end of the year.
C
The bond fund will yield a higher amount due to its higher interest rate, regardless of the compounding frequency.
D
The effect of the compounding interest cannot be evaluated without a given initial investment amount.
Explanation
Compare the effective annual rates. The bond fund earns (1 + 0.05/2)² − 1 = 5.0625%, while the money market fund earns (1 + 0.049/12)¹² − 1 ≈ 5.01%. So, for the same initial investment, the bond fund earns more interest over one year. The monthly compounding helps the money market fund, but not enough to offset its lower rate.
AI-written and checked against the verified answer.