Casey has $1 comma 000 to invest in a certificate of deposit. Her local bank offers her 2.50 % on a twelve-month FDIC-insured CD. A nonfinancial institution offers her 5.20 % on a 1twelve-month CD. What is the risk premium? What else must Casey consider in choosing between the two CDs?

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Business

Lyla Henry

20 July, 12:22

Casey has $1 comma 000 to invest in a certificate of deposit. Her local bank offers her 2.50 % on a twelve-month FDIC-insured CD. A nonfinancial institution offers her 5.20 % on a 1twelve-month CD. What is the risk premium? What else must Casey consider in choosing between the two CDs?

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Memphis Herrera · Answer 1

the risk premium = return of the deposit - risk free deposit return

risk premium = 5.2% - 2.5% = 2.7% or $27 for a $1,000 CD

Besides the investment risk, Casey must also consider the inflation rate and taxes. The inflation rate lowers the real interest earned by Casey: real interest rate = nominal interest rate - inflation rate. And she must also find out how the return from the non-financial institution is taxed, if it can be taxed as capital gains or regular income.