Difficulty: Easy

Average Score: 100%

What does it mean if a bank's advertisement for a certificate of deposit (CD) indicates a 4% APY?

Rationale

The CD will earn 4% interest each year that is then added to the CD's balance.

An APY, or Annual Percentage Yield, indicates the total amount of interest a bank pays on a deposit account, such as a certificate of deposit (CD), over a year, including compounding. Thus, a 4% APY means that the interest earned will be calculated at a rate of 4% annually and added to the principal balance, leading to growth in the total amount held in the CD.

A (The CD matures at the rate of 4% each year.) YOUR ANSWER

This statement is misleading because the maturity of a CD refers to the time period after which the principal and interest can be withdrawn, not the rate at which it matures. The 4% APY refers specifically to the interest earned, not to the duration or timing of maturity.

B (Only 4% of the CD's value can be withdrawn in any given year.) YOUR ANSWER

This interpretation incorrectly suggests a restriction on withdrawals based on the APY. APY indicates interest earned, not a limit on the amount that can be withdrawn. In fact, most CDs have specific terms regarding withdrawals, which are unrelated to the percentage yield.

C (You will pay 4% of the CD's value each year in service fees.) YOUR ANSWER

This option misrepresents the APY as a fee rather than a yield. The APY reflects earnings on the deposit, not costs incurred. Typically, service fees would be outlined separately, and the APY does not imply any payment requirement.

Conclusion

The APY of 4% on a certificate of deposit signifies that the account will earn 4% interest annually, which is compounded and added to the principal balance. This means that the investment grows over time, making it an attractive option for savers. The other options incorrectly interpret the nature of the APY, confusing it with maturity terms, withdrawal limits, or service fees. Understanding APY is crucial for making informed financial decisions regarding savings and investments.

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HiSET Missouri Exam Math Section

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