Future Business Leaders of America (FBLA) Business Calculations Practice Test

Which term describes the cost of using borrowed funds?

1. Principal

2. Interest

3. Equity

4. Debt service

The correct answer is: Interest

The term that describes the cost of using borrowed funds is interest. When an individual or a business borrows money, they are not just borrowing the principal amount, which is the original sum borrowed; they are also agreeing to pay back additional money as a fee for the privilege of using those funds. This fee is known as interest and is usually expressed as a percentage of the principal over a specific period. Interest reflects the compensation that lenders receive for the risk of lending money and for the opportunity cost of not being able to use that money elsewhere. It typically accrues over time and can vary based on several factors, including creditworthiness, the term of the loan, and prevailing economic conditions. This characteristic makes understanding interest essential for making informed financial decisions regarding borrowing and investing. While the other terms listed have relevant contexts in finance, they do not specifically convey the cost associated with the act of borrowing. Principal refers to the original amount borrowed, equity relates to ownership in an asset, and debt service refers to the total amount of money required to cover interest and principal repayments over a specified period.