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Compound Interest PDF

Compound interest is interest calculated on the initial principal and also on the accumulated interest from previous periods. It is computed at the end of each interest period and added to the principal for the next period. The effective interest rate, which is the actual interest earned in one year, may differ from the nominal rate depending on the number of compounding periods per year. Formulas are provided to calculate future worth given present worth, principal, interest rate, and number of compounding periods or years. Continuous compounding is also discussed, where interest is compounded an infinite number of times per year.

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KATE SARAH MARANAN
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66 views2 pages

Compound Interest PDF

Compound interest is interest calculated on the initial principal and also on the accumulated interest from previous periods. It is computed at the end of each interest period and added to the principal for the next period. The effective interest rate, which is the actual interest earned in one year, may differ from the nominal rate depending on the number of compounding periods per year. Formulas are provided to calculate future worth given present worth, principal, interest rate, and number of compounding periods or years. Continuous compounding is also discussed, where interest is compounded an infinite number of times per year.

Uploaded by

KATE SARAH MARANAN
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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COMPOUND INTEREST n = total number of compoundings EXAMPLE:

COMPOUND INTEREST n = (t)(m) 1. Consider a bank deposit of P1,000.00 to


- Interest is computed every end of each I = Interest earn 6% compounded quarterly. How
interest period. r = nominal interest rate much is the interest in one year?
- Interest earned for that period is added to E.R. = Effective Interest Rate 2. What rate of interest compounded
the new principal. t = number of years of investment annually must be received if an
Example: Consider an investment of P1,000.00 to m = compoundings per year investment of P54,000.00 made now will
earn 10% per year in three years. result in a receipt of P72,000.00 five years
If Simple Interest: To Compute F given P: from now?
F = P(1 + i)n 3. If P500,000.00 is deposited at a rate of
11.25% compounded monthly, determine
Note: The term (1 + i)n is called “Single
the interest after 7 years and 9 months.
Payment Compound Amount Factor”
CONTINOUS COMPOUNDING
To Compute P given F: - Interest may be computed daily, hourly,
P = F(1 + i)-n per minute, etc.
Note: The term (1 + i)-n is called “Single - Limit of interest may be considered to be
Payment Present Amount Factor” compounded infinite number of times
If Compound Interest: annually.
- m= Ꝏ
Values of i and n:
- the future worth of P at an interest rate of r
Nominal interest rate = 12%
- is compounded continuously for t years.
Number of years of investment = 5 years

• Annually (m = 1) F = (P)(ert)
r 0.12
i= = = 𝟎. 𝟏𝟐
m 1
n = (t)(m) = (5)(1) = 5 Example: The nominal interest rate is 4%.
• Quarterly (m = 4) How much is P10,000.00 worth in 10 years
r 0.12 in a continuously compounded account?
i=
m
=
4
= 𝟎. 𝟎𝟑 Given:
Elements of Compound Interest: P = P10,000.00
P = Present Worth/Principal n = (t)(m) = (5)(4) = 20
• Semi-Annually (m = 2) r = 0.04
F = Future Worth t = 10 years
i = effective interest per compounding period • Monthly (m = 12)
• Bimonthly (m = 6) F = (P)(ert)
(per interest period) F = (10,000)(e(0.04)(10))
r • Weekly (m = 52)
i= F = P14,918.25
m
NOMINAL AND EFFECTIVE RATE Example: What interest compounded monthly is
Nominal Rate equivalent to an interest rate of 14%
- rate quoted in a given variety of compounded quarterly?
compound interest. Given:
Effective Rate Compounded Monthly:
- the actual interest earned in one year. m = 12
Example: Consider a bank deposit of P1000.00 to Compounded Quarterly:
earn 6% compounded quarterly. m=4
Given: r = 0.14
P = P1000.00 ERmonthly = ERQuarterly
r = 0.06
i = 0.06/4 𝑟 12 0.14 4
(1 + 12) -1 = (1 + ) -1
n = 1(4) 4
r = 0.1384 = 13.84%
F = P(1 + i)n
F = (10000)(1+0.06/4)1(4)
Thus 14% compounded quarterly will have the
F= P1061.36
same interest as 13.84% compounded monthly.
**But notice that 1061.36 is not 6% but 6.136% of
P1000.00

𝒓 𝒎
ER = (𝟏 + ) -1
𝒎

Thus the effective rate od 6% compounded


quarterly is:

0.06 4
ER = (1 + 4
) -1

ER = 0.06136 = 6.136%

Essentially, the effective rate compounded


continuously is:

ER = er – 1

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