Question

Question

You have just received a bonus of 15,000 euros and have decided that you want to invest the
money. After discussing your options with your bank, you have narrowed it down to two options:
A. A savings account that provides 7% simple interest annually.
B. A savings account that provides 6.25% compounded interest annually.
Assume that the deposit is made in year 0 and payments are made at the end of periods with first
payment end of year 1.
1. What is the difference between simple and compounded interest?
2. You have decided to leave the money in the account for 12 years. Which option should you
choose?
3. In which year does option B become more favorable than option A?

A) Simple interest means interest accured on the principal amount clubbing considering interest already earned for that principal. The bank Considers only Principal outstanding while calculating interest pay out. while in compound interest method bank will consider principal and interest outstanding at the time of interest or principal Payment.

precisely compound interest means Interest on interest earned and Initial Principal.

B)

 15000 Prinicpal O/s Simple int Compound Aggregate simple Aggregate compound Compound Closinf 0 0 1 15000 1050 937.5 1050 937.5 15937.5 2 15000 1050 996.0938 2100 1933.59375 16933.59375 3 15000 1050 1058.35 3150 2991.943359 17991.94336 4 15000 1050 1124.496 4200 4116.439819 19116.43982 5 15000 1050 1194.777 5250 5311.217308 20311.21731 6 15000 1050 1269.451 6300 6580.66839 21580.66839 7 15000 1050 1348.792 7350 7929.460164 22929.46016 8 15000 1050 1433.091 8400 9362.551424 24362.55142 9 15000 1050 1522.659 9450 10885.21089 25885.21089 10 15000 1050 1617.826 10500 12503.03657 27503.03657 11 15000 1050 1718.94 11550 14221.97635 29221.97635 12 15000 1050 1826.374 12600 16048.34988 31048.34988 Total interest 12600 16048.35

Thus Total Interest earned Option B is more than Option A i.e 16048.35 > 12600 Option B must be choosen.

C)Option B is favourable from the Year 5 as highlighted in the above table.

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