Question 5

The future value of a series of payments increases when the compounding frequency increases.

Increasing the compounding frequency leads to a higher future value of a series of payments, as interest is calculated and added to the principal more frequently, resulting in more interest being earned over time.

A) It stays the same, only decreases in the rate will impact future value.

This option is incorrect because it suggests that the future value remains unchanged regardless of the compounding frequency, which does not align with the principles of compound interest. In reality, an increase in compounding frequency enhances the accumulation of interest.

B) It decreases.

This option is incorrect as it contradicts the fundamental concepts of finance. When compounding frequency increases, the future value should not decrease; rather, it should increase due to the effect of earning interest on previously accumulated interest.

C) It increases.

This option is correct because with more frequent compounding, interest is calculated on a smaller principal more often, leading to a greater accumulation of interest over time and thus a higher future value.

D) It stays the same, only increases in the rate will impact future value.

This option is incorrect because it implies that compounding frequency has no effect on future value, which is not true. While interest rates are a factor, the frequency of compounding also plays a crucial role in determining how much interest is earned.

Conclusion

The correct answer is that the future value of a series of payments increases with more frequent compounding. This is due to the nature of compound interest, where interest on interest leads to greater overall returns. All other options fail to recognize the significant impact that compounding frequency has on future value calculations.