annualized return of an investment depends on whether or not the return, including interest and dividends, from one period is reinvested in the next period. If the return is reinvested, it contributes to the starting value of capital invested for the next period (or reduces it, in the case of a negative return). Compounding reflects the effect of the return in one period on the return in the next period, resulting from the change in the capital base at the start of the latter period. For example, if an investor puts $1,000 in a 1-year certificate of deposit (CD) that pays an annual interest rate of 4%, paid quarterly, the CD would earn 1% interest per quarter on the account balance. The account uses compound interest, meaning the account balance is cumulative, including interest previously reinvested and credited to the account. Unless the interest is withdrawn at the end of each quarter, it will earn more interest in the next quarter. At the beginning of the second quarter, the account balance is $1,010.00, which then earns $10.10 interest altogether during the second quarter. The extra dime was interest on the additional $10 investment from the previous interest accumulated in the account. The annualized return (annual percentage yield, compound interest) is higher than for simple interest because the interest is reinvested as capital and then itself earns interest. The yield or annualized return on the above investment is . Foreign currency returns As explained above, the return, or rate or return, depends on the currency of measurement. In the example given above, a US dollar cash deposit which returns 2% over a year, measured in US dollars, returns 12.2% measured in Japanese yen, over the same period, if the US dollar increases in value by 10% against the Japanese yen over the same period. The return in Japanese yen is the result of compounding the 2% US dollar return on the cash deposit with the 10% return on US dollars against Japanese yen: 1.02 x 1.1 − 1 = 12.2% In more general terms, the return in a second currency is the result of compounding together the two returns: where is the return on the investment in the first currency (US dollars in our example), and is the return on the first currency against the second currency (which in our example is the return on US dollars against Japanese yen). This