Question 28

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

A bank's advertisement indicating a 4% APY means that the certificate of deposit will earn 4% interest annually, which is compounded and added to the principal balance of the CD. This results in the total value of the CD increasing over time as interest is accrued.

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

This option is incorrect because a 4% APY does not refer to the maturity of the CD; rather, it specifies the interest rate earned on the investment. Maturity refers to the end date of the investment period, not the growth rate.

B) Only 4% of the CD's value can be withdrawn in any given year.

This option is incorrect as it misinterprets the meaning of APY. The 4% APY does not limit withdrawals but indicates the annual interest earned, which is not tied to a percentage of withdrawal capability.

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

This option is also incorrect because the APY does not imply any fees associated with the CD. Instead, it reflects the interest income generated by the investment, not an expense incurred.

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

This option is correct because it accurately describes the function of the APY. A 4% APY indicates that the interest earned each year will be calculated and compounded, increasing the total balance of the CD.

Conclusion

The correct understanding of a 4% APY is crucial for evaluating the potential earnings from a certificate of deposit. It indicates that the CD will earn interest annually, which compounds to enhance the investment's value. All other options misinterpret the nature of APY, focusing on withdrawal limitations or fees rather than the income generated through interest.