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Interest Compounded Continuously

The document explains the concept of continuously compounded interest using the formula A = Pe^(rt), where A is the accumulated value, P is the principal, r is the annual interest rate, and t is the time in years. It provides examples of calculating the future value of investments with continuous compounding and compares different investment options. Additionally, it emphasizes the importance of using a calculator for accurate results and following the order of operations.

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3 views4 pages

Interest Compounded Continuously

The document explains the concept of continuously compounded interest using the formula A = Pe^(rt), where A is the accumulated value, P is the principal, r is the annual interest rate, and t is the time in years. It provides examples of calculating the future value of investments with continuous compounding and compares different investment options. Additionally, it emphasizes the importance of using a calculator for accurate results and following the order of operations.

Uploaded by

laonewendy269
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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16-week Lesson 30 (8-week Lesson 24) Interest Compounded Continuously

As shown in Lesson 29, one application of exponential functions is


compound interest, which is when interest is calculated on the total value
of a sum and not just on the principal like with simple interest. We saw in
Lesson 29 that one way interest can be compounded is 𝑛 times per year,
where 𝑛 represents some number of compounding periods (quarterly,
monthly, weekly, daily, etc.). The other way interest can be compounded
is continuously, where interest is compounded essentially every second of
every day for the entire term. This means 𝑛 is essentially infinite, and so
we will use a different formula which contains the natural number 𝑒 to
calculate the value of an investment. The formula for interest
compounded continuously is 𝐴 = 𝑃𝑒 𝑟𝑡 .
Formula for Interest Compounded Continuously:
- when interest is compounded continuously, we use the formula
𝐴 = 𝑃𝑒 𝑟𝑡
o when interest is compounded continuously, there are essentially
an infinite number of compounding periods (𝑛 → ∞), so that is
why we use the natural number 𝑒
o 𝐴 is the accumulated value of the investment
o 𝑃 is the principal (the original amount invested)
o 𝑟 is the annual interest rate
o 𝑡 is the number of years the principal is invested (the term)
Example 1: If $17,000 is invested at a rate of 6.25% per year for
39 years, find value of the investment to the nearest penny if the interest is
𝑟 𝑛𝑡
compounded continuously. Use either 𝐴 = 𝑃 (1 + 𝑛) or 𝐴 = 𝑃𝑒 𝑟𝑡 .

𝐴 = 𝑃𝑒 𝑟𝑡

𝐴 = 17000𝑒 (0.0625)(39)
𝐴 = 17000𝑒 2.4375
𝐴 = 17000(11.44439396 … )

𝑨 = $𝟏𝟗𝟒, 𝟓𝟓𝟒. 𝟕𝟎
1
16-week Lesson 30 (8-week Lesson 24) Interest Compounded Continuously

When working with compound interest formulas, remember to keep


in mind order of operation (PEMA):
1. simplify parentheses
2. simplify exponents
3. simplify multiplication/division, working from left to right
4. simplify addition/subtraction, working from left to right

Example 2: If $20,000 is invested at a rate of 6.5% per year compounded


continuously, find value of the investment at each given time and round to
𝑟 𝑛𝑡
the nearest cent. Use either 𝐴 = 𝑃 (1 + 𝑛) or 𝐴 = 𝑃𝑒 𝑟𝑡 .

a. 8 months b. 18 months c. 21 years d. 100 years

For each of these problems you will use the formula 𝐴 = 𝑃𝑒 𝑟𝑡 since
interest is compounded continuously. The principal will be 20000 for
each problem part (𝑃 = 20000) and the interest rate will be 6.5%
(𝑟 = 0.065). However the term will vary from part to part:

8 2 18
𝑡 = 12 = 3 𝑡 = 12 = 1.5 𝑡 = 21 𝑡 = 100

2
0.065∙
𝐴 = 20000𝑒 3

Once again do your best to leave all calculated values in your calculator.
2
0.065∙
For instance when calculating 𝐴 = 20000𝑒 3 from Example 2 part a,
2
0.065∙
do not calculate 𝑒 and then try to write that down on paper to 5 or 6
3

decimal places. Leave calculated values in your calcul ator to avoid


approximating.
Once again for help with entering expressions such as
2 2
0.065∙
𝐴 = 20000𝑒 0.065∙
3 20000𝑒 3
in your calculator, take a look at the
Calculator Tips document in Brightspace or stop by my office
hours. Also, be sure to use the same calculator on homework
𝑨 = $𝟐𝟎, 𝟖𝟖𝟓. 𝟕𝟐 (handheld or computer calculator) as you will on the exam.

2
16-week Lesson 30 (8-week Lesson 24) Interest Compounded Continuously

Example 3: A recent college graduate decides to open a credit card in


order to pay for their upcoming trip across Europe. In order to get a card
with a large enough credit limit to pay for their trip ($5,500), the student
agrees to an interest rate of 38.99% compounded continuously. If no
payments are made for an entire year, what will be the balance on the card
𝑟 𝑛𝑡
rounded to the nearest penny? Use either 𝐴 = 𝑃 (1 + 𝑛) or 𝐴 = 𝑃𝑒 𝑟𝑡 .

Example 4: Parents of a newborn baby are given a gift of $20,000 and


will choose between two options to invest for their child’s college fund.
Option 1 is to invest the gift in a fund that pays an average annual interest
rate of 8% compounded semiannually; option 2 is to invest the gift in a
fund that pays an average annual interest rate of 7.75% compounded
continuously. Assuming each investment has a term of 18 years, calculate
the value of each investment and round your answer to the nearest penny.
𝑟 𝑛𝑡
Use either 𝐴 = 𝑃 (1 + 𝑛) or 𝐴 = 𝑃𝑒 𝑟𝑡 .

Option 1 =

Option 2 =

If the rates are the same, which is the better option for the parents?

3
16-week Lesson 30 (8-week Lesson 24) Interest Compounded Continuously

Answers to Examples:
1. $194,554.70 ; 2a. $20,999.16 ; 2b. $22,048.23 ; 2c. $78,314.46
; 2d. $13,302,832.66 ; 3. $8,122.58 ;
4. Option 1 = $82,078.65 ; Option 2 = $80,699.49 ;
if the rates are equal, Option 2 is the better option ;

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