GRE General TestQuantitative ReasoningMedium
A financial analyst is evaluating two investment options. Option A guarantees a simple interest rate of 6% per year. Option B offers a compound interest rate of 5.5% per year, compounded annually. If an initial investment of $10,000 is made for 3 years, what is the difference in the total interest earned between Option B and Option A?
- A$18.75
- B$10.50
- C$15.00
- D$22.50
Show answer & explanationAnswer & explanation
Correct answer: B. $10.50
Calculate the simple interest for Option A and the compound interest for Option B over 3 years. Then find the difference between the two interest amounts.
Why the other options are wrong
- A. This value is incorrect; a common error might be misapplying the compounding formula.
- C. This value is incorrect; likely a miscalculation of one or both interest types.
- D. This value is incorrect; potentially a simple interest calculation error or swapped rates.
Simple vs. Compound Interest
Simple interest is calculated only on the principal amount, while compound interest is calculated on the principal amount and also on the accumulated interest of previous periods.
- Simple Interest Formula: I = P * R * T
- Compound Interest Formula: A = P * (1 + R)^T (where A is total amount, I = A - P)
- Compound interest generally yields more over longer periods due to interest on interest.
Memory trick: Simple's Steady, Compound's Climb: Calculate each path, then find the gap.