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Assignment 4

This document describes and compares discrete and continuous compounding interest. Discrete interest is calculated and added to the principal at specified intervals like monthly, quarterly, or annually. Continuous interest is calculated at every moment on an exponential scale. In general, continuous compounding results in higher future values than discrete compounding due to its exponential calculation. Graphs and examples are provided to illustrate the difference between the two methods.

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156 views

Assignment 4

This document describes and compares discrete and continuous compounding interest. Discrete interest is calculated and added to the principal at specified intervals like monthly, quarterly, or annually. Continuous interest is calculated at every moment on an exponential scale. In general, continuous compounding results in higher future values than discrete compounding due to its exponential calculation. Graphs and examples are provided to illustrate the difference between the two methods.

Uploaded by

John Wick
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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Assignment # 4

Describe the difference between discrete and continuous compounding interest?


Draw a general graph explaining their difference.

Discrete Compounding Interest Continuous Compounding Interest


When interest is calculated and added to When interest is being calculated at every
the principal amount at specified intervals moment, strictly speaking, then such an
i.e., monthly, quarterly, annually, then interest is known as continuous
such an interest is known as discrete compounding interest. It is calculated on
compounding interest. an exponential scale.
In discrete compounding interest future In continuous compounding interest future
value F is calculated as: value F is calculated as:
r mt F = Pⅇrt
F = P (1 + )
m where P = Principal Amount
where P = Principal Amount r = Interest Rate
r = Interest Rate t = Term of contract in year
m = Number of Compounding e = Euler’s Number = 2.71828
Periods per year
t = Term of contract in year

In general, discrete compounding interest Continuous compounding interest is


is less than continuous compounding generally greater than discrete
interest. compounding interest.
Example: Example:
If a person has taken a loan of $1000 from If a person has taken a loan of $1000 from
a bank for 15 years at an interest rate of a bank for 15 years at an interest rate of
10% which is compounded once in a year 10% which is compounded continuously
than using the formula for discrete than using the formula for continuous
compounding interest the amount he will compounding interest the amount he will
have to pay after 15 years is $4177.25. have to pay after 15 years is $4481.69.

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Figure 1 shows how interest is compounded continuously and discretely in the above-
mentioned example

Figure 1: On left Discrete Compounding and on right continuous compounding is


depicted
Figure 2 shows how in continuous compounding future amount increases from discrete
compounding.

Figure 2: Variation of future amount in discrete and continuous compounding


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