Question

Christina invested $3,000 five years ago and earns 2 percent interest on her investment. By leaving her interest earnings in her account, she increases the amount of interest she earns each year. The way she is handling her interest income is referred to as which one of the following?

Answer 1

Answer:

The question is incomplete, the complete question is given as follows:

Christina invested $3,000 five years ago and earns 2 percent annual interest. By leaving her interest earnings in her account, she increases the amount of interest she earns each year. The way she is handling her interest income is referred to as:

A) simplifying.

B) compounding.

C) aggregating.

D) accumulating.

E) discounting.

Answer:

B) Compounding

Explanation:

Compound interest : This is the interest earned on both the principal amount plus any already earned interest i.e the compound amount. Here, interest is earning interest!

Under the compound interest, interest for a period is computed by multiplying the interest rate by the principal amount plus already earned interest. This will will done weekly, if the interest rate is quoted to be compounded weekly

For example, if an investment promises 10% per annum and I invested $10,000 for 2 years. My interest will be computed as follows:

Interest earned per year will be as follows:

Year 1 = 10% × $10,000= $1,000

Year 2= (10% ×10,000) + (10% ×$1,000)= $1,100

Total interest = $2,100

The total worth of the investment after the the investment period is called the Future Value i.e the principal + interest earned

Simple interest: Under the simple interest, interest is earned only on the principal amount only.

Simple interest = Principal × rate × time

using the same illustration above,  we can compute the simple interest;

simple interest (S.I) = 10,000 × 10% × 2

Total interest for 2 years=  $2,000

Note that the interest under compound system is higher by $100 simply  because interest is earning interest.

By interest earning interest; it is called compounding.