Multiple Choice
Which term best describes the process where interest is earned on both the initial principal and on interest previously earned?
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10. Time Value of Money
Time Value of Money Equations
Multiple Choice
A certificate of deposit pays a higher interest rate than a savings account because the money is:
A
insured for a higher amount by the FDIC
B
invested in riskier assets by the bank
C
subject to daily compounding interest
D
locked in for a fixed period and cannot be withdrawn without penalty
Verified step by step guidance1
Understand the concept of a certificate of deposit (CD): A CD is a financial product offered by banks that provides a fixed interest rate in exchange for keeping the money deposited for a specified period.
Recognize the key feature of a CD: The money is locked in for a fixed period, meaning the depositor cannot withdraw the funds without incurring a penalty.
Compare a CD to a savings account: Unlike a savings account, which allows flexible withdrawals, a CD requires the depositor to commit to a fixed term, which is why it typically offers a higher interest rate.
Clarify why the interest rate is higher: Since the bank can rely on the funds being available for a fixed period, it can use them for longer-term investments, allowing it to offer a higher return to the depositor.
Understand the penalty for early withdrawal: If the depositor withdraws funds before the maturity date, they will face a penalty, which reinforces the fixed-term nature of the CD.
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