Multiple Choice
Approximately what annual interest rate, compounded annually, is needed to double an investment in 4 years?
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10. Time Value of Money
Time Value of Money Equations
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Which one of the following best defines the compounding of interest?
A
Earning interest on both the initial principal and the accumulated interest from previous periods.
B
Calculating the present value of a future cash flow.
C
Earning interest only on the initial principal amount.
D
Paying interest on a loan at a fixed rate each period.
Verified step by step guidance1
Understand the concept of compounding interest: Compounding interest refers to the process where interest is calculated not only on the initial principal amount but also on the accumulated interest from previous periods.
Compare the options provided in the problem: Analyze each option to determine which one aligns with the definition of compounding interest.
Option 1: 'Earning interest on both the initial principal and the accumulated interest from previous periods' matches the definition of compounding interest.
Option 2: 'Calculating the present value of a future cash flow' refers to a different concept in financial accounting, known as discounting, not compounding interest.
Option 3: 'Earning interest only on the initial principal amount' describes simple interest, which is distinct from compounding interest.
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