CS Executive · Corporate Accounting and Financial Management · Time Value of Money
When the number of compounding periods per year increases, with the nominal annual rate and the time period unchanged, what happens to the future value of a lump sum?
The future value increases. With more frequent compounding, interest is credited to the principal sooner and itself earns interest, so the effective annual rate rises above the nominal rate. The nominal rate and time are unchanged, but the maturity amount is higher.
- AIt decreases
- BIt remains the same
- CIt increasesCorrect
- DIt becomes equal to simple interest value
Explanation
More frequent compounding means interest is added to principal sooner and earns further interest, so the effective rate rises above the nominal rate. Hence the future value increases, though at a decreasing rate.
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