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Student

Date

Period

12-2

Determining the Effective Annual Yield

The annual yield of a CD is the rate at which your money earns simple interest in 1 year. Effective annual yield is influenced by the frequency of compounding. Yield is the rate of return on your investment and is usually expressed as a percentage.

Example Find the effective annual yield to the nearest thousandth percent. Morgana LeFey invested $10,000 in a 5-year certificate of deposit that earns an interest rate of

    • 5.75

      percent compounded quarterly.

    • 1.

      Find the amount. (Refer to the Amount of $1.00 Invested table on page 180.) Amount Original Principal Amount per $1.00 for One Year $10,000 1.058752 $10,587.52

2. Find the interest for 1 year.

3. Find the effective annual yield.

Interest Amount Principal $10,587.52 $10,000 $587.52

Effective Annual Yield Interest for One Year Principal $587.52 $10,000 5.875% effective annual yield

Practice

Annual

Interest

Original

Interest

Effective

Rate

Period

Principal

Amount

Earned

Annual Yield

Find the amount, the interest earned, and the effective annual yield. (Refer to the Amount of

$1.00 Invested table on page 180.)

5. Al Holman can invest $15,000 at 5.25 percent interest in a 4-year CD compounded monthly or quarterly. What is the effective annual yield of each? 6. Marybeth Evanston can invest $7,500 in a 1-year CD earning 3 percent interest compounded daily or a 1-year CD earning 3.25 percent interest compounded quarterly. Which earns a higher effective annual yield? 7. Felix Capistrano invests $25,000 in a 4-year CD earning 5.5 percent interest compounded quarterly. What is the effective annual yield? 8. Standardized Test Practice Robert and Katie Masterson have the option of investing their $20,000 savings in a 4-year CD earning 5.00 percent interest compounded daily, 5.25 percent interest compounded monthly, or 5.50 percent interest compounded quarterly. Based on the annual effective yield, which is the best investment?

A. 5% compounded daily

B. 5.25% compounded monthly

C. 5.5% compounded quarterly

D. They all earn the same annual effective yield.

1.

5.50%

1 year monthly

$ 5,000

a.

b.

c.

2.

4.75%

1 year daily

9,700

a.

b.

c.

3.

4.50%

1 year quarterly

11,250

a.

b.

c.

4.

5.25%

1 year monthly

14,875

a.

b.

c.

Copyright © by The McGraw-Hill Companies, Inc. All rights reserved.

Section 12-2

Study Guide

81

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