Multiple Choice
How does an increase in the interest rate affect the amount of money earned on a savings account over time, assuming all other factors remain constant?
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10. Time Value of Money
Time Value of Money Equations
Multiple Choice
When interest accrues and is added to the principal balance of a student loan, which of the following best describes the result?
A
The total amount owed decreases because the interest is paid off immediately.
B
The principal balance remains unchanged, and only the interest amount increases.
C
The total amount owed increases because future interest is calculated on a higher principal.
D
The loan is paid off faster because interest is added to the principal.
Verified step by step guidance1
Understand the concept of accrued interest: Accrued interest is the interest that accumulates on a loan over time but has not yet been paid. When this interest is added to the principal balance, it increases the total amount owed.
Recognize the impact of adding accrued interest to the principal: When interest is added to the principal balance, the new principal becomes larger. Future interest calculations will be based on this higher principal amount, leading to an increase in the total amount owed over time.
Clarify why the total amount owed increases: Since future interest is calculated as a percentage of the principal balance, a higher principal results in higher interest charges. This process is known as compounding, where interest is earned or charged on previously accrued interest.
Eliminate incorrect options: The total amount owed does not decrease because the interest is not paid off immediately. The principal balance does not remain unchanged because accrued interest is added to it. The loan is not paid off faster because adding interest to the principal increases the total amount owed, potentially extending the repayment period.
Conclude with the correct explanation: The total amount owed increases because future interest is calculated on a higher principal balance, which is the result of adding accrued interest to the original principal.
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