Which of the following are the two most common types of interest used in time value of money calculations?

• A. Fixed interest and variable interest
• B. Simple interest and compound interest
• C. Nominal interest and effective interest
• D. Annual percentage rate and periodic rate

Answer: (B)

Verified step by step guidance

1. Understand the concept of 'time value of money,' which refers to the idea that money available today is worth more than the same amount in the future due to its earning potential.
2. Learn about 'simple interest,' which is calculated only on the principal amount of a loan or investment. The formula for simple interest is: $I=P\times r\times t$, where I = interest, P = principal, r = rate, and t = time.
3. Understand 'compound interest,' which is calculated on the principal amount and also on the accumulated interest from previous periods. The formula for compound interest is: $A=P(1+r)n^{}$, where A = total amount, P = principal, r = rate, and n = number of compounding periods.
4. Compare simple interest and compound interest to understand their differences. Simple interest grows linearly, while compound interest grows exponentially due to the compounding effect.
5. Recognize that simple interest and compound interest are the two most common types of interest used in time value of money calculations because they represent fundamental methods of calculating the growth of money over time.