Suppose you invest $10,000 in a savings account earning 2% interest (compounded

Question

Suppose you invest $10,000 in a savings account earning 2% interest (compounded yearly) with no risk. After 7 years, how much will you have?

Repeat Question #1, but this time there is an inflation rate of 4%. How does this change your overall return on investment? If you had a chance to invest in an account with a long-term expected rate of 5%, with a 50% chance of earning 0% nominal compound interest and a 50% chance of earning 10% nominal compound interest in each year, would you choose this account, or the savings account? Why?

Explanation / Answer

Amount invested @ 2% p.a compounded for 7 years = 10000 (1+.02)^7 =$ 11486.86 Amount invested @ 4% p.a compounded for 7 years = 10000 (1+.04)^7 =$ 13159.32 Amount invested @ 5% p.a compounded for 7 years = 10000 (1+.05)^7 =$ 14071

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