Question

Instruction: Answer in a Word file and submit. Show the formula and all corresponding numbers you use in the formula. Do NOT use spreadsheet and submit.

1. (3 points)     You deposit your $10,000 in a new savings account that earn 4 % annually. You don’t take the interest out and keep it in the savings account so that you can earn interest on interest (compounding!). What would be the value of the $10,000 after 40 years? (Show your calculation)

2. (3 Points)    Your deposit $10,000 in a mutual fund earning 7 % on average. You don’t take the interest out and keep it in the savings account so that you can earn interest on interest. What would be the value of the $10,000 after 40 years? (Show your calculation)

3. (4 Points)    If you have only $10,000 and have to pick only one, what would you pick? Savings account or mutual fund? Write pros and cons of your choice.

Answer 1

1). Given that,

PV = $10000 invested in a saving account

Interest earned r = 4%

Time period of investment t= 40 years

So, Value in account after 40 years using compounding is

FV = PV*(1+r)^t = 10000*1.04^40 = $48010.21

Final value in account = $48010.21

2).

PV = $10000 invested in a mutual fund account

average Interest earned r = 7%

Time period of investment t= 40 years

So, Value in account after 40 years using compounding is

FV = PV*(1+r)^t = 10000*1.07^40 = $149744.58

Final value in account = $149744.58

3). As seen from the above, Mutual fund account has yield more than 3 times than investing in saving account, Mutual fund should be picked.

Main differentiating points in mutual funds and saving account:

1). Returns:

Saving account yield less as compared to average return on a mutual fund account.

2). Risk:

Saving accounts are almost risk free in nature but Mutual fund are subject to market risk.

3). Ease:

With the digital revolution, investing in mutual funds is as easy as opening a savings account. Once your KYC formalities have been completed, you are all set to start putting your money in. You can maintain a zero balance in your savings account, but of course, your money will grow only with the amount you keep putting in.