Which concept describes interest calculated and paid on capital plus any interest earned up to that point?

• A. Discounting (interest)
• B. Present value
• C. Adjustment factor
• D. Compounding (interest)

Answer: (D)

Compounding occurs when interest is calculated on the original capital plus any interest that has already been earned. Each period, you earn interest on a larger amount because the previous interest adds to the principal. For example, 100 invested at 5% grows to 105 after one year, then to 110.25 after the second year, since the 5% in the second year applies to 105. This is often written as the amount = principal × (1 + rate)^time.

This differs from simple interest, where interest is earned only on the original principal each period. It also differs from discounting or present value, which is about working backward to determine today’s value of a future sum, rather than how money grows over time. The term adjustment factor isn’t the standard description of this growth process.

So the described idea—earning interest on the capital plus any previously earned interest—is compounding.