$1000 invested at 5% annually, compounded annually, for 2 years yields what amount?

• A. 1000
• B. 1050
• C. 1102.5
• D. 1110

Answer: (C)

When interest compounds annually, you multiply the initial amount by (1 plus the annual rate) for each year. Start with 1000. After one year: 1000 × 1.05 = 1050. After the second year: 1050 × 1.05 = 1102.5. Equivalently, 1000 × (1.05)^2 = 1102.5. The extra growth comes from earning interest on the previous year’s interest. So the amount after two years is 1102.5.