2. Suppose a bank offers you the following two year, non-cashable GICs (i.e., wi

Question

2. Suppose a bank offers you the following two year, non-cashable GICs (i.e., withdrawals are not allowed). The first one pays a monthly rate of return 0.245%, the second one pays a semi-annual rate of return of 1.47% and the third one a return of 2.75% for the first year and 3.25% for the second year. All interest payments are reinvested (a) Which investment would you prefer? (b) Suppose you expect that interest rates decline to 3% after the first year. How does your answer change, if the two year GIC pays out the first interest payment (but not the principal) at the end of the first year?

Explanation / Answer

Suppose I invest $100

a. A monthly payment would give me = 100(1 + 0.245/100)24

= 100(1.00245)12 = 100*1.06048 = $106.048

b. Semi Annual = 100(1 + 1.47/100)4 = 100(1.0147)4 = 100 * 1.06010 = $106.01

c. Annual = 100(1+ 3.25/100)2 = 100(1.0325)2 = $106.60

Hence, the annual payment is the most profitable and should be preferred as can be seen from the calculations above.

2. 100(1+3.25/100)(1+3/100) = 100(1.0325)(1.03) = $106.35

Even after this, the answer will not change.

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