Jack has $1,000 that he wishes to invest for the next two years.One-year CDs are currently paying 8% while two-year CDs are paying 12% per annum.Economists are predicting that interest rates will rise by the end of the year.What is the minimum amount interest rates would have to increase to in order for the one-year CD to be better than the two-year CD?

Question

Quizplus · Accepted Answer

To make the one-year CD better, the interest rate for the second year must be high enough so that the total interest over two years exceeds the 12% per annum of the two-year CD. If Jack invests in a one-year CD at 8%, he will have $1,080 after the first year. For the one-year CD to be better, the second year's rate must be such that $1,080 * (1 + x) > $1,000 * (1.12)^2. Solving for x gives approximately 16%.

Jack Has $1,000 That He Wishes to Invest for the Next