Question

Two investments have an expected life of five years. One promises to pay 6% annual interest, the other 10%. Explain why there are differences in expected rates of return on the two investments.

Answer 1

The expected rates of return on investments differ based on the interest rates offered. The investment with a higher interest rate typically has a higher expected rate of return.

Step-by-step explanation:

The expected rate of return on an investment is influenced by the interest rate offered. In this case, one investment promises to pay 6% annual interest while the other promises to pay 10%. The difference in the expected rates of return on the two investments is due to the difference in the interest rates offered.A higher-risk investment does not necessarily mean a low return; it could also yield high returns. Risk refers to the uncertainty of returns, which could be high or low.

For example, if you invest $100 in the first option with a 6% annual interest rate, you would expect to receive $6 in interest every year. However, if you invest the same $100 in the second option with a 10% annual interest rate, you would expect to receive $10 in interest every year. Therefore, the second investment has a higher expected rate of return compared to the first investment.