Question

Assume that you have $3000 to invest for 5 years. You could purchase a 5-year CD with a guaranteed interest rate of 2.52% compounded monthly. On the other hand, if you are willing to face the risk of actually losing your money, you could invest it in the stock market which has an historical return rate of about 6.5% per year. Think of this as investing your money in a non-guaranteed account that pays 6.5% APR compounded annually.

With the specific interest rates quoted, how much more interest could you potentially earn by putting your money in the stock market for 5 years instead of in the CD? Round your answer to the nearest whole dollar.

Answer 1

Solution:

First calculate the total interest on CD over 5 years;

Future value=Amount invested*[1+(interest rate)/no. of compounding in year)]^no. of years*no. of compounding

=$3000*[1+(0.0252/12)]^5*12

=$3402.40

Total interest earned in case of CD=Future value-Amount invested

=$3402.40-$3000

=$402.40

Now,calculate total interest earned by investing in stock market as follow:

Future value=Amount invested*[1+(interest rate)/no. of compounding in year)]^no. of years*no. of compounding

=$3000[1+(0.065/1)]^5*1

=$4110.26

Interest earned in case of stock market=$4110.26-$3000

=$1110.26

Thus extra interest earned by putting your money in the stock market for 5 years instead of in the CD is;

=$1110.26-$402.40

=$707.86