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Question: Rosa invests $3000 in an account with an APR of 4% and annual compounding. Julian...

Question: Rosa invests $3000 in an account with an APR of 4% and annual compounding. Julian invests $2500 in an account with an APR of 5% and annual compounding.

A) Compute the balance in each account after 5 and 20 years.

B) Determine, for each account and for the periods of 5 and 20 years, the percentage of the balance that is interest.

Follow-up

Answer the following questions:

Comment on the effect of interest rates and patience.

In the long-term, who made the better investment choice, and why?

Provide some rationale for someone choosing Rosa’s investment option over Julian’s.

Provide some rationale for someone choosing Julian’s investment option over Rosa’s.

Expert Solution

Q1: Comment on the effect of interest rates and patience.

Ans: The formula for compounding interest is as follows

Amount (Fv) = Principal (Pv) x (1+Rate) ^ Time

We have 3 variables which determines future value ... Principal, Rate & Time

Higher the Principal, higher the Maturity

Higher the Rate, higher the Maturity

Higher the Time, higher the Maturity

Among three most powerful is Time, which gives exponential effect. As an investor we should focus on the principal & time, but we cannot control the returns which is not in our hand. We can choose the asset class which has potential to give better return.

Q2: In the long-term, who made the better investment choice, and why?

Ans: In long run Julian will get higher maturity as her rate of return is higher compare to Rosa and because of compounding effect, she will score more.

Q3: Provide some rationale for someone choosing Rosa’s investment option over Julian’s.

Ans: As principal displayed by Rosa is higher compare to Julian, however investment rate of Rosa is lower. If someone is investing till 19 years, Rosa will score more.

Q4: Provide some rationale for someone choosing Julian’s investment option over Rosa’s.

Ans: As rate of return of Julian is higher than Rosa, in long term (=>20 years) Julian will get benefited because of the compounding effect. It means if someone is investing for more than 20 years, Julian will score more.

jeff jeffy answered 2 years ago

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