Question

Suppose you invest $5,000 in a certificate of deposit that pays 3% for 5 years. If simple interest is paid, you will have a lower balance at the end of three years compared to if compound interest was paid.

a) True
b) False

Answer 1

The statement is false; compound interest results in a higher balance than simple interest over the same period because it takes into account the interest that has accumulated in addition to the principal.

Step-by-step explanation:

The statement is false. Simple interest and compound interest are two different ways in which interest can be calculated on an investment such as a certificate of deposit (CD). Simple interest is calculated on the principal amount only, while compound interest is calculated on the principal amount plus any interest that has been earned previously over the term of the investment.

If you invest $5,000 at 3% for 5 years with simple interest, the interest is calculated as follows:

Interest = Principal x Rate x Time = $5,000 x 0.03 x 5 = $750

The total balance after 5 years = Principal + Interest = $5,000 + $750 = $5,750.

For compound interest, assuming it is compounded annually:

Final balance = Principal x (1 + Rate)^Time = $5,000 x (1 + 0.03)^5 ≈ $5,796.14

Therefore, you would have a higher balance at the end of 3 years if compound interest is applied.