LEARNING MODULE IN APPLIED MATHEMATICS OF INVESTMENT

Lesson 2
Compound Interest

Topic Objective/s:
At the end of this lesson, you are must have:
Described the nature of compound interest.
Solved problems involving compound interest.

Keywords
List the keywords in Lesson 2.

Let’s Look Back!

In the previous lesson, simple interest has been discussed as a type of interest. You have
learned that it is computed entirely on the original principal by simply multiplying together the
principal, rate, and time (I=PRT).
Suppose you borrowed Php 1,000 from a student-loan program which charges 12% for
one year. How much is the interest that you have to pay?
To solve the problem:
Given:
P= 1,000
R= 12% or .12
T= 1 year
Solution:
I= PRT
I= (1,000)(.12)(1)
I= Php120
 With interest of Php120, you have to pay Php1,120 (1,000+120) at the end of the 1-year
term of the loan.
Simple interest is the type of interest commonly used for short-term loans or investments
having a term of 1year or less. However, for long-term obligations/investments, interest is added
to the principal and the resulting amount becomes the new principal for the next interest period.
This is called compound interest. You will learn more about this as we proceed with this lesson.

Let’s Learn! “The greatest law in

the universe is the
Law of Compound
Interest!”
-Albert Einstein

2.1 Nature of Compound Interest

Very few banks today pay interest based on the
simple interest formula. Instead, they pay interest by
using a principle called compounding.
Source: https://dribbble.com/shots/5698774-Albert-Einstein Compound interest refers to the sum of interests’
prior periods computed on the original or principal amount and each of successive periods on
both the principal and interest. It is earned on a given deposit that has become part of the
principal at the end of a specified period.
Unlike simple interest, compound interest on an amount accumulates at a faster rate than
simple interest. The basic idea is that after the first interest period, the amount of interest is
added to the principal amount and then the interest is computed on this higher principal. The
result is a much faster growth of money than simple interest would yield.
The process of adding the interest due to the new principal in succeeding periods
continues until the due date is known as compounding amount.

2.2 Compound Amount

Compound amount is the accumulated value of the principal and all interest amounts prior
periods. In other words, it is the sum of the principal and all compound interest.
 Interest is said to be compounded monthly, quarterly, semi-annually, or annually. When the
conversion periods are:

Annually n=1 Monthly n=12

Semi-annually n=2

Quarterly n=4
LEARNING MODULE IN APPLIED MATHEMATICS OF INVEST
The formula for the computation of the compound amount is as follows:

=  + r nt
Ap1
 n

Where:

A = Total amount
p = principal
r = interest rate
n = number of compounding periods
t = time in years

Let us look at some examples.

***Illustration 2.1
Grace and Donna deposited Php8,000 in a savings account at 5%. If interest is
compounded monthly, what will the amount of their deposit be at the end of two years?
Given:
P= 8,000
R= 5% or .05
T= 2 years
n= 12 (compounded monthly)

Solution:
A= p (1+ r/n)nt
A= 8,000 (1+.05/12)12(2)
A= 8,000 (1+.05/12)24
A= Php8, 839.39

***Illustration 2.2
 Mr. Fuentes deposited Php50, 000 in a commercial bank at 3% interest rate per annum
compounded quarterly for 1 year. (a) How much is the compound interest every quarter? (b)
How much is the total quarterly compound interest in one year? TMENT
a. How much is the compound interest every quarter?

First Quarter Compound Interest (CI1Q)

First quarter compound interest is determined by multiplying the principal amount by the
interest rate and by quarterly or 3 months (0.25).

CI1Q = (p) (r) (Q1)

Where:

CI1Q = compound interest for first quarter

P = principal amount
R = interest rate
Q1 = quarter or 3 months (0.25)

Given:
CI1Q =?
P = 50,000
r = 3% per annum
Q1 = quarter or 3 months (0.25)

Solution:
CI1Q = (p) (r) (Q1)
= (50,000) (.03) (.25)
CI1Q = Php375.00 The first quarter compound interest is Php375.00.

First Quarter New Balance (Q1NB)

First quarter new balance is determined by adding the principal amount and first quarter
compound interest.

Q1NB = p + CI1Q

Where:
Q1NB = First quarter new balance

p = principal

CI1Q = First quarter compound interest

Given:
Q1NB =?
p = 50,000
CI1Q = 375

Solution:
Q1NB = p + CI1Q
Q1NB = 50,000 + 375

Q1NB = Php50,375.00
Second Quarter Compound Interest (CI2Q)
Second quarter compound interest is obtained by multiplying the first quarter new
balance by interest rate and by quarterly or 3 months (0.25).

CI2Q = (Q1NB) (r) (Q2)

Where:
CI2Q = compound interest for second quarter
Q1NB = first quarter new balance
r = interest rate
Q2 = second quarter

Solution:

CI2Q = (Q1NB) (r) (Q2)

CI2Q = (50,375) (.03) (.25)
CI2Q = Php377.8125 The second quarter compound interest is Php377.812

Second Quarter New Balance

Second quarter new balance is determined by adding first quarter new balance and the
second quarter compound interest.

Q2NB = Q1NB + CI2Q

Where:
Q2NB = Second quarter new balance

Q1NB = First quarter new balance

CI2Q = Second quarter compound interest

Given:
Q2NB =?

Q1NB = 50,375

CI2Q = 377.8125

Solution:

Q2NB = Q1NB + CI2Q

= 50, 375 + 377.8125

Q2NB = Php50, 752.8125

Third Quarter Compound interest (CI3Q)

Third quarter compound interest is obtained by multiplying the second quarter new
balance by the interest and by the quarter or 3 months (0.25)

CI3Q = (Q2NB) (r) (Q3)

Where:
CI3Q = third quarter compound interest
Q2NB = second quarter new balance
r = rate
Q3 = third quarter

Given:
CI3Q =?
Q2NB = 50,752.8125
r = 3%
Q3 = 0.25

Solution:
CI3Q = (Q2NB) (r) (Q3)
= (50,752.8125) (0.03) (0.25)
CI3Q = Php380.65 The third quarter compound interest is Php380.65

Third Quarter New Balance (Q3NB)

Third quarter new balance is obtained by adding the second quarter new balance and
the third quarter compound interest.

Q3NB = Q2NB + CI3Q

Where:
Q3NB = third quarter new balance
Q2NB = second quarter new balance
CI3Q = third quarter compound interest

Given:
Q2NB = 50,752.8125
CI3Q = 380.65

21
 LEARNING MODULE IN APPLIED MATHEMATICS OF INVESTMENT

Solution:
Q3NB = Q2NB + CI3Q
= 50,752.8125 + 380.65
Q3NB = Php51, 133.4625

Fourth Quarter Compound interest (CI4Q)

Fourth quarter compound interest is determined by multiplying the third quarter new
balance by the interest and by the fourth quarter.

CI4Q = (Q3NB) (r) (Q4)

Where:
CI4Q = fourth quarter compound interest
Q3NB = third quarter new balance
r = rate
Q4 = fourth quarter

Given:
CI4Q =?
Q3NB = 51,133.4625
r = 3%
Q4 = 0.25

Solution:
CI4Q = (Q3NB) (r) (Q4)
= (51,133.4625) (0.03) (0.25)
CI4Q = Php383.5010 The fourth quarter compound interest is Php383.5010

Fourth Quarter New Balance (Q4NB)

Fourth quarter new balance is obtained by adding the third quarter new balance and
the fourth quarter compound interest.

Q4NB = Q3NB + CI4Q

Where:
Q4NB = fourth quarter new balance
Q3NB = third quarter new balance
CI4Q = fourth quarter compound interest
LEARNING MODULE IN APPLIED MATHEMATICS OF INVESTMENT

Given:
Q4NB = ?
Q3NB = 51,133.4625
CI4Q = 383.5010
Solution:
Q4NB = Q3NB + CI4Q
= 51,133.4625 + 383.5010
Q4NB = Php51,516.9635

b. How much is the total quarterly compound interest in one year?

Given:
CI1Q = Php375.00
CI2Q = Php377.8125
CI3Q = Php380.65
CI4Q = Php383.5010
Total = Php1, 516.9635

***Illustration 2.3
Accumulate Php15,000 for 5 years at 6% compounded quarterly.
Given:
P= 15,000
R= 6% or .06
T= 5 years
n= 4 (compounded quarterly)

Solution:
A= p (1+ r/n)nt
A= 15,000 (1+.06/4)4(5)

A= 15,000 (1+.06/4)20
A= Php 20, 202.83
ARNING MODULE IN APPLIED MATHEMATICS OF INVESTMENT

Let’s Try!

Mr. Borromeo borrowed P80,000.00 from the lending institution at 15% interest rate per
annum compounded quarterly for 1 year.

1. How much is the compound interest every quarter?

2. How much is the total compound interest for 1 year?

3. How much is the fourth quarter new balance at the end of the year?
 LEARNING MODULE IN APPLIED MATHEMATICS OF INVESTMENT

Let’s Do This!
Solve the following problems:
1) A man borrowed Php20, 000 at 8% compounded semi-annually. How much will he have
to pay at the end of 5 years?

2) A man died leaving his 15 year-old son an amount of Php25, 000 which is deposited in a
bank at 6% interest compounded monthly. If money was left in the bank and was allowed
to accumulate, how much will the boy receive when he reaches the age of 25?

3) Mrs. Yang borrowed Php30, 000 on June 1, 2016 and paid it on December 1, 2019 with
interest at 6% compounded semi-annually. How much did she pay then?
ATICS OF INVESTMENT

4) Mr. Hasin Dero made a time deposit of five million pesos in a savings bank. The deposit was
left to accumulate at 10% compounded quarterly. Find the compounded amount at the end
of the term.

5) Mrs. Yu borrowed Php200, 000 from the bank at 20% interest rate per annum compounded
semi-annually for 2 years. (a) How much is the compound interest every semi-annual? (b)
How much is the compounded amount at the end of two years?