In: Finance
Rishi Singh has
$1,600
to invest. His investment counselor suggests that Rishi should buy an investment that pays no interest but will be worth
$2,100
after
7
years.
a. What average annual rate of return will Rishi earn with this investment?
b. Rishi is considering another investment, of equal risk, that earns an annual return of
1.96%
. Which investment should he make, and why?
a. The annual rate of return Rishi will earn with this investment,
r,
is
nothing%.
(Round to two decimal places.)b. Rishi is considering another investment, of equal risk, that earns an annual return of
1.96%
. Which investment should he make, and why? (Select the best answer below.)
A.Rishi should accept the investment that will return
$2,100
because it has a higher return for the same amount of risk.
B.Rishi should accept the investment that will return
$2,100
because it has a lower return for the same amount of risk.
C.Rishi should accept the investment with the return of
1.96%
because it has a higher return for the same amount of risk.
D.Rishi should accept the investment that will return
$2,100
because it has a higher return for less risk.
Answer :
Calculation of Average Annual Rate of Return for Rishi:
Rate of Return = Return from the Investment / Investment Amount
Rate of Return for 7 years = ( $2100 - $1600 ) / $1600
= 0.3125 or 31.25 %
31.25% is the rate of return for 7 years.
Therefore Average Annual Rate of Return = 31.25% / 7
= 4.46% annual
Comparison between the two investments and final answer :
As mentioned in the Question that both the investments have equal risk therefore Rishi should select the investment that will give more annual rate of return. The investment that returns $2100 gives annual return of 4.46% and the other investment gives annual rate of return of 1.96%. Therefore first investment that return $2100 and provides 4.46% return annual should be accepted.
From the given options, Option A is correct because this investment has higher return for the same amount of risk, as explained above.
Therefore Option A is the Correct Answer.
Reasoning for other options:
Option B is incorrect because investment that will return $2100 give higher return not lower.
Option C is incorrect because Investment with return of 1.96% has lower return not higher.
Option D is incorrect because Both the investments has same risk.