Exercise #1: A person invests $500 in an account that earns a nominal yearly interest rate of 4%. (a) How much would this investment be worth in 10 years if the compounding frequency was once per year? Show the calculation you use. (b) If, on the other hand, the interest was applied four times per year (known as quarterly compounding), why would it not make sense to multiply by 1.04 each quarter? (c) If you were told that an investment earned 4% per year, how much would you assume was earmed per quarter? Why? (d) Using your answer from part (c), calculate how much the investment would be worth after 10 years of quarterly compounding? Show your calculation.
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Since the nominal yearly interest rate is 4% and the interest is applied quarterly, we need to divide the yearly interest rate by the number of compounding periods per year. In this case, the compounding frequency is four times per year, so we divide 4% by 4 to Show more…
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