Compounding period

Definition

A compounding period is the interval at which interest is calculated and added to the principal balance of an investment or loan. It determines how often interest accumulates, impacting the total amount of interest paid or earned.

5 Must Know Facts For Your Next Test

1. The frequency of compounding periods can be annually, semi-annually, quarterly, monthly, daily, or continuously.
2. More frequent compounding periods result in higher amounts of accumulated interest over time due to the effect of compound interest.
3. The formula for compound interest takes into account the number of compounding periods per year.
4. Compounding periods are crucial in calculating both future value and present value in financial equations.
5. Understanding compounding periods helps in comparing different investment opportunities and loan offers.

Review Questions

• How does the frequency of compounding periods affect the total amount of interest earned or paid?
• What are common intervals used for compounding periods?
• Why is it important to consider the number of compounding periods when calculating future value?

Related terms

Principal: The initial amount of money invested or borrowed before interest is applied.

Compound Interest: Interest calculated on both the initial principal and the accumulated interest from previous periods.

Future Value: The value of an investment after it has earned interest over one or more compounding periods.