Grant is considering two investment opportunities: 1. a bond fund with an annual interest rate of 5% , compounded semiannually 2. a money market fund with an annual interest rate of 4.9% , compounded monthly Evaluate the financial data for a one-year period. Which statement is true about the effect of the compounding periods on the total interest earned?
Answer
A
The bond fund will yield a higher amount due to its higher interest rate, regardless of the compounding frequency.
B
Both investment options will yield the same amount at the end of the year.
C
The effect of the compounding interest cannot be evaluated without a given initial investment amount.
D
The money market fund will yield a higher amount due to its more frequent compounding, despite its slightly lower interest rate.
Explanation
Compare the effective annual rates. The bond fund earns (1 + 0.05/2)² − 1 = 5.0625%, while the money market fund earns (1 + 0.049/12)¹² − 1 ≈ 5.01%. So, for the same initial investment, the bond fund earns more interest over one year. The monthly compounding helps the money market fund, but not enough to offset its lower rate.
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