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Chapter 3
Compounding and discounting
2.1 Compounding
A sum invested today will earn interest. Compounding calculates the future (or
terminal) value of a given sum invested today for a particular time period at a
particular rate of interest.
It assumes that interest is earned not just on the initial investment amount but also on
interest already earned.
Formula for compounding:
F = P(1+r) n F = Future value
P = Initial investment (present value)
r = Interest rate
n = number of time periods
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