Question

Chris wants to deposit $100 in a bank for two years. He can either 1) leave the money for two years and earn an annual rate of 11% or 2) deposit money for one year and earn annual interest rate of 10%, then come back to the bank and re-deposit the original investment plus earned interest for another year. What value of one-year interest rate one year from now would yield the very same outcome for Chris if he chooses option #2 compared to how much he would collect after two years is he goes with option #1?

A.

1%

B.

12.01%

C.

9.01%

D.

11.50%

E.

21%

F.

12.50%

G.

11.02%

H.

10.50%

Answer 1

Answer:

Correct answer is:

B. 12.01%

Explanation:

Option 1:

Deposit = $100

Annual rate = 11%

Duration = 2 years

Amount Chris will get = FV = PV * (1 + Annual rate) ^2 = 100 * (1 + 11%) ^2 = $123.21

Option 2:

Deposit = $100

Annual rate = 10%

Duration = 1 years

Amount Chris will get after 1 year = 100 * (1 + 10%) = $110

We need to find one-year interest rate one year from now would yield the very same outcome for Chris if he chooses option #2 compared to how much he would collect after two years is he goes with option #1

Required one-year interest rate one year from now would be = (123.21/ 110 -1) * 100 = 12.02%

Required one-year interest rate one year from now would be = 12.01%

Option B is correct and other options A and C to H are incorrect.