Question

What is the power of compounding and provide two examples? In contrast, what is the term discounting in how it differs from compounding.?

Answer 1

ANS: Compounding refers to the re-investment of earning at the same rate of return along with the amount of principal year after year. Compunding helps a sum of money to grow at a fastest rate than the simple Interest because interest is being charged over interest whick makes it cumulative.

Examples are -

1. Investment in Mutual fund
2. Investment in Fixed deposit in Bank

On the Other hand, Discounting is a process of determining the present value of cash flow. It is the present value of a sum of money at a specified rate of return.

The Key Distinction between the Compounding & Discounting are -

• Compounding is a method that used to know the future value of present amount, whereas Discounting determines the present value of received in future.
• Compounding uses compound rate of interest while Discounting uses discounting rate.