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On the first of the year, James invested x dollars at Proudstar bank  [#permalink]

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Question Stats: 51% (02:11) correct 49% (02:44) wrong based on 791 sessions

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On the first of the year, James invested x dollars at Proudstar bank in an account that yields 2% in interest every quarter year. At the end of the year, during which he made no additional deposits or withdrawals, he had y dollars in the account. If James had invested the same amount in an account which pays interest on a yearly basis, what must the interest rate be for James to have y dollars at the end of the year?

A. 2.04%
B. 6.12%
C. 8%
D. 8.25%
E. 10%

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Re: On the first of the year, James invested x dollars at Proudstar bank  [#permalink]

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Hi, there. I'm happy to help with this. Essentially, this question is asking for the effective interest rate.

So, every increase of 2% means we multiply x by the multiplier 1.02. The initial amount x gets multiplied by this multiply four times, one for each quarter, so . . .

y = x*(1.02)^4 = (1.08243216)*x ====> effective interest = 8.2432%

That's how you'd get the exact answer with a calculator, but of course you don't have a calculator available on GMAT PS questions. Think about it this way. With simple interest, 2% a quarter would add up to 8% annual. With compound interest, where you get interest on your interest, you will do a little better than you would with simple interest, so the answer should be something slightly above 8%. That leads us to . . .

Does that make sense? Please let me know if you have any additional questions on what I've said there.

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Re: On the first of the year, James invested x dollars at Proudstar bank  [#permalink]

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iwillcrackgmat wrote:
On the first of the year, James invested x dollars at Proudstar bank in an account that yields 2% in interest every quarter year. At the end of the year, during which he made no additional deposits or withdrawals, he had y dollars in the account. If James had invested the same amount in an account which pays interest on a yearly basis, what must the interest rate be for James to have y dollars at the end of the year?

A. 2.04%
B. 6.12%
C. 8%
D. 8.25%
E. 10%

If the interest were compounded annually instead of quarterly then in one year the interest would be 2*4=8%. Now, since the interest is compounded quarterly then there would be interest earned on interest (very small amount) thus the actual interest would be a little bit more than 8%, only answer choice D fits.

Similar questions to practice:
jolene-entered-an-18-month-investment-contract-that-127308.html
marcus-deposited-8-000-to-open-a-new-savings-account-that-128395.html

Hope it helps.
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Re: On the first of the year, James invested x dollars at Proudstar bank  [#permalink]

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mikemcgarry wrote:
Hi, there. I'm happy to help with this. Essentially, this question is asking for the effective interest rate.

So, every increase of 2% means we multiply x by the multiplier 1.02. The initial amount x gets multiplied by this multiply four times, one for each quarter, so . . .

y = x*(1.02)^4 = (1.08243216)*x ====> effective interest = 8.2432%

That's how you'd get the exact answer with a calculator, but of course you don't have a calculator available on GMAT PS questions. Think about it this way. With simple interest, 2% a quarter would add up to 8% annual. With compound interest, where you get interest on your interest, you will do a little better than you would with simple interest, so the answer should be something slightly above 8%. That leads us to . . .

Does that make sense? Please let me know if you have any additional questions on what I've said there.
Mike But according to compound interest formula y= x*( 1+ 0.02/4(quarterly)^time(1yr)*4(quarterly) -> so it comes to x* (1.02015). Please correct me where I'm going wrong.
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Re: On the first of the year, James invested x dollars at Proudstar bank  [#permalink]

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romeokillsu wrote:
But according to compound interest formula y= x*( 1+ 0.02/4(quarterly)^time(1yr)*4(quarterly) -> so it comes to x* (1.02015). Please correct me where I'm going wrong.
Thanks

Dear romeokillsu,
My friend, in most standard problems, the interest rate given is an ANNUAL interest rate, and for compounding quarterly, we have to divide it by four, as that formula does. BUT, in this problem we are told:

On the first of the year, James invested x dollars at Proudstar bank in an account that yields 2% in interest every quarter year.

So, this problem is following a different pattern --- it is not giving us an ANNUAL interest rate that needs to be divided by four. It is giving us a QUARTERLY interest rate.

That formulas you cited is only used when the problem gives us an annual interest rate. DO NOT blindly apply formulas! That is a recipe for failure! You must understand WHY the formula is true. You have to be able to recreate the argument whereby you derive the formula from scratch. That is really understanding, and that is what the GMAT is testing. Knowing just the formula and not where it comes from, not why it is true, is precisely the kind of superficial knowledge that the GMAT loves to exploit and punish.

For more on the compounding interest formula, see this blog:
http://magoosh.com/gmat/2014/compound-i ... -the-gmat/

Does all this make sense?
Mike _________________
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Re: On the first of the year, James invested x dollars at Proudstar bank  [#permalink]

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Per quarter, interest = 2%

So for a year, interest = 8%

Due to quarter cummulation, effective yield (YTM) would be slight higher than 8%

Answer = 8.25% = D

Note: I've not made any calculations here; solved conceptually
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Re: On the first of the year, James invested x dollars at Proudstar bank  [#permalink]

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El ejercicio solicita comparar interés compuesto con interés simple:

Recordemos que:

1 trimestres = 3 meses, entonces 1 año = 4 trimestres = 12 meses.

Cuestión planteada por el ejercicio:

Cierta cantidad a un interes trimestral del 2%, pasado un año, debe ser igual a la misma cierta cantidad a la cuál se le aplica un interes desconocido (lo que se pregunta) anual. ¿ cuál es este último interés anual?

El interés del 2% trimestral, ya que involucra más de un período en el año, corresponde a interés compuesto, modelo
x(1 + 2/100)^4 = aproximadamente pero mayor que x(1 + o,o8).

Es decir la misma cierta cantidad a un interés anual cercano pero ligeramente mayor al 8% (interes simple), equivale a la cierta cantidad con un interés del 2% trimestral al finalizar una año (interés compuesto).

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Re: On the first of the year, James invested x dollars at Proudstar bank  [#permalink]

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Quarterly interest rate is not the same as annual interest rate compounded quarterly. We are given quarterly interest rate, therefore we do not need to divide by 4 in the compound interest formula.

ACCT A: x(1.02)^4=y
ACCT B: x(1+r)=y

x(1.02)^4=x(1+r)
(1.02)^4=(1+r)
0.0824=r

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Re: On the first of the year, James invested x dollars at Proudstar bank  [#permalink]

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mikemcgarry wrote:
Hi, there. I'm happy to help with this. Essentially, this question is asking for the effective interest rate.

So, every increase of 2% means we multiply x by the multiplier 1.02. The initial amount x gets multiplied by this multiply four times, one for each quarter, so . . .

y = x*(1.02)^4 = (1.08243216)*x ====> effective interest = 8.2432%

That's how you'd get the exact answer with a calculator, but of course you don't have a calculator available on GMAT PS questions. Think about it this way. With simple interest, 2% a quarter would add up to 8% annual. With compound interest, where you get interest on your interest, you will do a little better than you would with simple interest, so the answer should be something slightly above 8%. That leads us to . . .

Does that make sense? Please let me know if you have any additional questions on what I've said there.

Mike Hi Mike,
I have a confusion here.Where in the question it is mentioned that we need to check t he COMPOUND INTEREST?

In QUESTION STEM
If James had invested the same amount in an account which pays interest on a yearly basis, what must the interest rate be for James to have y dollars at the end of the year?

Here it says "interest rate /per year" Nowhere it us mentioned "Compounded annually"??

IN my opinion it should be Simple interest?No?
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Re: On the first of the year, James invested x dollars at Proudstar bank  [#permalink]

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er.arun88 wrote:
Hi Mike,
I have a confusion here.Where in the question it is mentioned that we need to check t he COMPOUND INTEREST?

In QUESTION STEM
If James had invested the same amount in an account which pays interest on a yearly basis, what must the interest rate be for James to have y dollars at the end of the year?

Here it says "interest rate /per year" Nowhere it us mentioned "Compounded annually"??

IN my opinion it should be Simple interest?No?

Dear er.arun88,

I'm happy to respond. There are two reasons why we can be 100% sure that compound interest in intended here.

1) The GMAT prepares you for the real business world and reflects the values of the real business world. Simple interest does not exist outside of kiddie math text books. No bank or credit card or financial institution on the planet would ever use simple interest: they all use compound interest. Thus, whenever the GMAT talks about interest and doesn't specify, we can be 100% sure that they mean compound interest. The GMAT would have to specify very clearly that they were using simple interest, although I don't know if I have ever even seen an official question about simple interest. It's true, the official GMAT is usually exceptionally clear, and probably would have said "compounds" rather than "yields" in the first sentence.

2) If there were no compounding, then in simple interest having the 2% interest accrue quarterly would make absolutely no sense, because by the end of the year, one would have exactly the same amount as an 8% annual account That essentially would be a question: do you know how to multiply by four? That is not the level at which the GMAT tests. The entire setup for the question is about measuring the compounding difference, and the subtle reasoning about how different the compound effects would be from the all-at-once interest payment is precisely what raises this question to the level of the conceptual complexity of the GMAT Quant section.

Does all this make sense?
Mike _________________
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Re: On the first of the year, James invested x dollars at Proudstar bank  [#permalink]

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But here they are asking for rate in compund interest anually right , soit should be less than compounded monthly rate right? Please help me!!
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Re: On the first of the year, James invested x dollars at Proudstar bank  [#permalink]

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Anazeer wrote:
But here they are asking for rate in compund interest anually right , soit should be less than compounded monthly rate right? Please help me!!

Dear Anazeer,

I'm happy to respond. When we have a quarterly interest rate, and these quarter compound, then over the course of a full year, the account makes a total amount of interested in the year that is more than it makes in any one quarter. Since all percentages are compared to the principal, which remains the same, the annual amount must be a larger percentage.

Does this make sense?
Mike _________________
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Re: On the first of the year, James invested x dollars at Proudstar bank  [#permalink]

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iwillcrackgmat wrote:
On the first of the year, James invested x dollars at Proudstar bank in an account that yields 2% in interest every quarter year. At the end of the year, during which he made no additional deposits or withdrawals, he had y dollars in the account. If James had invested the same amount in an account which pays interest on a yearly basis, what must the interest rate be for James to have y dollars at the end of the year?

A. 2.04%
B. 6.12%
C. 8%
D. 8.25%
E. 10%

We can let James’ initial investment of x be \$100. That is, we can say that James invested 100 dollars at Proudstar bank in an account that yields 2% in interest every quarter year. Recall the compound interest formula:

A = P(1 + i)^n

In which P = principal, i = interest rate per period, n = number of periods, and A = amount at the end of n periods.

Since a year has 4 quarters, n = 4 and we have:

A = 100(1 + 0.02)^4

A = 100(1.02)^4

A = 100(1.0824)

A = 108.24

We can see that he will get back \$108.24 when the interest is compounded quarterly, and this has to be the value of y (if x = 100). So the question becomes: if James had invested \$100 in an account that pays interest on a yearly basis, what must the interest rate be for James to have \$108.24 at the end of the year?

We can use the same formula, except now we need to solve for i when n = 1:

108.24 = 100(1 + i)^1

1.0824 = 1 + i

0.0824 = i

8.24% = i

We see that the closest answer choice is D: 8.25%.

Alternate solution:

In this problem, we are given that a certain amount of money is being compounded quarterly with an interest rate of 2%. That is like paying an annual interest rate of 8% (4 x 0.02 = 0.08), but SOMEWHAT BETTER, since the interest is compounded (i.e., interest added on principal plus interest) every quarter of the year. So we are looking for an annual interest rate of slightly more than 8%. The only two answer choices that are more than 8% are 8.25% and 10%. Recall, we’ve said “somewhat better,” so it can’t be 10%. This leaves 8.25% as the most reasonable answer choice and the correct answer choice.

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Re: On the first of the year, James invested x dollars at Proudstar bank  [#permalink]

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JeffTargetTestPrep wrote:
iwillcrackgmat wrote:
On the first of the year, James invested x dollars at Proudstar bank in an account that yields 2% in interest every quarter year. At the end of the year, during which he made no additional deposits or withdrawals, he had y dollars in the account. If James had invested the same amount in an account which pays interest on a yearly basis, what must the interest rate be for James to have y dollars at the end of the year?

A. 2.04%
B. 6.12%
C. 8%
D. 8.25%
E. 10%

We can let James’ initial investment of x be \$100. That is, we can say that James invested 100 dollars at Proudstar bank in an account that yields 2% in interest every quarter year. Recall the compound interest formula:

A = P(1 + i)^n

In which P = principal, i = interest rate per period, n = number of periods, and A = amount at the end of n periods.

Since a year has 4 quarters, n = 4 and we have:

A = 100(1 + 0.02)^4

A = 100(1.02)^4

A = 100(1.0824)

A = 108.24

We can see that he will get back \$108.24 when the interest is compounded quarterly, and this has to be the value of y (if x = 100). So the question becomes: if James had invested \$100 in an account that pays interest on a yearly basis, what must the interest rate be for James to have \$108.24 at the end of the year?

We can use the same formula, except now we need to solve for i when n = 1:

108.24 = 100(1 + i)^1

1.0824 = 1 + i

0.0824 = i

8.24% = i

We see that the closest answer choice is D: 8.25%.

Alternate solution:

In this problem, we are given that a certain amount of money is being compounded quarterly with an interest rate of 2%. That is like paying an annual interest rate of 8% (4 x 0.02 = 0.08), but SOMEWHAT BETTER, since the interest is compounded (i.e., interest added on principal plus interest) every quarter of the year. So we are looking for an annual interest rate of slightly more than 8%. The only two answer choices that are more than 8% are 8.25% and 10%. Recall, we’ve said “somewhat better,” so it can’t be 10%. This leaves 8.25% as the most reasonable answer choice and the correct answer choice.

Hello,

i have a doubt...shouldn't the "i" in the formula be divided by "n" as well where "n" is the number of times interest is compounded annually...and the answer comes out to be different in that case...please help me out Re: On the first of the year, James invested x dollars at Proudstar bank   [#permalink] 30 Jan 2019, 20:46
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