The Time Value of Money

Compounding

$1 invested today would be worth about $131.5 after 100 years if compounded annually at 5%.

The Future Value of a Single Cash Flow – Example

An Australian bank offers to pay you 6 percent compounded monthly. You decide to invest A$1 million for one year. What is the future value of your investment if interest payments are reinvested at 6 percent?

【PRACTICE PROBLEMS】

An investment of €500,000 today that grows to €800,000 after six years has a stated annual interest rate closest to:

A.       7.5% compounded continuously.

B.        7.7% compounded daily.

C.        8.0% compounded semiannually.

【PRACTICE PROBLEMS】

A bank quotes a stated annual interest rate of 4.00%. If that rate is equal to an effective annual rate of 4.08%, then the bank is compounding interest:

A.       daily.

B.        quarterly.

C.        semiannually.