Part A
Answer and its explanation:
Interest earned in the third year can be found from following two steps
Step 1 Use compounding formula for first two years, which is as under:
Future value = Present Value * (1+r)^n
Here n is the number of years the amount would be deposited for, which is 2 years duration. And r is the rate of return which is 8% here. So the future value in the year 2 will be:
Future value = $1000 * (1 + 0.08)^2 = $1166.4
Now the interest earned in the third year is:
Interest earned in the third year = $1166.4 * 8% = $93.312
Part B
Answer and its explanation:
The simple interest is the interest arising from the principal investment made in the year zero to date and this can be calculated as under:
Simple interest = Principal investment * rate of interest * number of years
Simple Interest = $1000 * 8% * 3years = $240
And the interest arising from the compounding of interest can be found by the difference of the Future value of the investment for three years and simple interest.
So,
Interest arising through compounding of interest = FV of investment in three years time - (Simple Interest + Principal investment)
Interest arising through compounding of interest = $1000*(1+0.08)^3 -$1240
= $19.712
