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Compounding

• The process of accumulating the time value of money forward in time. For example, interest earned in one period earns additional interest during each subsequent time period.

• The process of receiving interest on interest is called compounding.

• The ability of an asset to generate earnings that are then reinvested and generate their own earnings; making earnings off earnings.

 
 Embedded terms in definition
 Asset
Earnings
Forward
Interest on interest
Interest
Time value of money
Time value
Time
 
 Referenced Terms
 Annual percentage yield: Abbreviated APY. The effective, or true, annual rate of return. The APY is the rate actually earned or paid in one year, taking into account the affect of Compounding. The APY is calculated by taking one plus the periodic rate and raising it to the number of periods in a year. For example, a 1% per month rate has an APY of 12.68% (1.01^12).

 Compounding frequency: The number of Compounding periods in a year. For example, quarterly compounding has a compounding frequency of 4.

 Continuous compounding: The process of accumulating the time value of money forward in time on a continuous, or instantaneous, basis. Interest is earned continuously, and at each instant, the interest that accrues immediately begins earning interest on itself.Compounding of interest an infinite number of times per year at intervals of microseconds.

 Discounting: The present value calculation takes into account the fact that you will receive interest on interest. The process of calculating present value is called discounting. Discounted cash flow equals future cash flow divided by one plus the discount rate.Calculating the present value of a future amount. The process is opposite to Compounding.

 Discounting cash flows: The process of finding present values; the inverse of Compounding interest.

 
 Related Terms
 Compounding frequency
Compounding period
Continuous compounding
Discrete compounding
Quarterly compounding
Semi annual compounding

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