Fundamentals of Business Intelligence (FBI) Practice Exam

Which of the following describes the relationship between interest rates and time value of money?

1. Higher interest rates increase the future value

2. Lower interest rates decrease present value

3. There is no correlation between them

4. Interest rates are irrelevant to investment decisions

The correct answer is: Higher interest rates increase the future value

The selected answer accurately reflects the fundamental principles of finance concerning the time value of money. Higher interest rates positively influence the future value of an investment. When interest rates rise, the amount of money that will accumulate over time from an investment also increases. This is because interest is calculated as a percentage of the initial principal, and a higher rate yields more returns as the investment grows over time. Thus, if an individual invests a sum of money at a higher interest rate, the compounded interest will lead to a greater future value of that initial investment when compared to a scenario with lower interest rates. In contrast, the other options do not establish this relationship correctly. For instance, while lower interest rates can decrease the present value of future cash flows, stating outright that they decrease present value may lack nuance, as it overlooks various other factors like cash flow timing. Moreover, affirming that there is no correlation or that interest rates are irrelevant to investment decisions disregards key aspects of financial decision-making where interest rates significantly impact both present and future values.