Question

Suppose you are considering depositing $1,000 in bank CDs. CD1 will pay 5% per year for three years, and CD2 will pay 8% for the first year, 5% for the second year, and 3% the third year. Which CD should you choose?

Answer 1

Option 1: Investing in CD1

Year	Opening Balance	Deposit	Interest @5%	Closing balance
1		$1,000	$50	$1,050
2	$1,050	$0	$52.50	$1,102.50
3	$1,102.50	$0	$55.13	$1,157.63

Value after 3 Years is $ 1157.63

Option 2: Investing in CD2

Rate of Interest in first year = 8% p.a

We know that Future value = Present value ( 1+i)^n

Where n= Number of years and i= Rate of interest

Future value = $ 1000( 1+8/100)^1

= $ 1000*1.08

= $ 1080

Then the $ 1080 is Compounded at 5% for seconnd year

Future value = $ 1080( 1+5/100)^1

=$ 1080( 1.05)

=$ 1134

Then $ 1134 is Compounded at 3% rate of interest

Future Value = $ 1134( 1+3/100)^1

= $ 1134*1.03

= $ 1168.02

So the Value after 3 years is $ 1168.02

The value of CD2 is higher than CD1.So CD2 is good to invest.

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