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Compound Interest

The document discusses compound interest, providing formulas for simple interest, compound interest, and continuous compounding. It defines annual, semiannual, quarterly, monthly, weekly, and daily compounding periods. Examples are given for calculating interest charged on an unpaid balance, annual rate of return on an investment doubling in value over 2 years, comparing investments earning different interest rates compounded semiannually and continuously, time for an investment to double at 5% continuous compounding, and annual interest rate needed to double an investment over 5 years.

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Johnry Dayupay
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223 views17 pages

Compound Interest

The document discusses compound interest, providing formulas for simple interest, compound interest, and continuous compounding. It defines annual, semiannual, quarterly, monthly, weekly, and daily compounding periods. Examples are given for calculating interest charged on an unpaid balance, annual rate of return on an investment doubling in value over 2 years, comparing investments earning different interest rates compounded semiannually and continuously, time for an investment to double at 5% continuous compounding, and annual interest rate needed to double an investment over 5 years.

Uploaded by

Johnry Dayupay
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 PPT, PDF, TXT or read online on Scribd
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COMPOUND INTEREST

Making or Spending Money
SIMPLE INTEREST FORMULA
 If a principal of P dollars is borrowed for a period 
of t years at a per annum interest rate r, 
expressed as a decimal, then interest I charged is

I = Pr t
 This interest is not used very often. Interest is 
usually compounded which means interest is 
charged or given on the interest and the 
principal.

 Simple Interest Example
COMPOUND INTEREST
 Payment Periods:
 Annually Once per year 
 Semiannually Twice per year
 Quarterly Four times per year
 Monthly Twelve times per year
 Weekly Fifty two times per year
 Daily 365 (360 by banks) per year
COMPOUND INTEREST FORMULA
 The amount A after t years due to a principal P 
invested at an annual interest rate r compounded 
n times per year is 
nt
� r�
A = P�
1+ �
� n�

 A is commonly referred to as the accumulated 
value or future value of the account. P is called 
the present value.
COMPOUND INTEREST
 Example:
 Investing $1000 at an annual rate of 8% 
compounded annually, quarterly, monthly, and 
daily will yield the following amounts after 1 
year:
 Annually

 Quarterly

 Monthly

 Daily
COMPOUND INTEREST
 On­line example

 More on­line examples
COMPOUND INTEREST
 Tutorial
Continuous Compounding
 The amount A after t years due to a
principal P invested at an annual
interest rate r compounded
continuously is

A = Pe rt
FINDING EFFECTIVE RATE OF 
INTEREST
 Definition

 Steps for Finding ERI: (If a P is not given, use $100)
1. Find the value of the interest compounded annually 
for one year
2. Find the value of the interest compounded for the 
given amount of times annually
3. Find the interest by subtracting (Step 2 – original 
principal)
4. Divide the answer by the original principal (if using 
100 don’t have to because it’s already written as a 
percent).
EFFECTIVE RATE OF INTEREST
 Finding Interest Video
 What is the Effective Rate of Interest for 5.25% 
compounded quarterly?
 Step 1: 100(1 + .0525)(1) = A

 A = 105.25

4
Step 2:  100 �
.0525 �
 1+
� �
� 4 �
= 105.35
 Step 3: 105.35 – 100 = 5.35
 Step 4: 5.35%
PRESENT VALUE FORMULAS
 The present value P of A dollars to be received 
after t years, assuming a per annum interest rate 
r compounded n times per year, is

- nt
� r�
P = A� 1+ �
� n�
If the interest is compounded continuously, then
P = Ae - rt
EXAMPLES
 Sears charges 1.25% per month on the unpaid 
balance for customers with charge accounts 
(interest is compounded monthly). A customer 
charges $200 and does not pay her bill for 6 
months. What is the bill at that time?
EXAMPLES
 Tracy is contemplating the purchase of 100 
shares of stock selling for $15 per share. The 
stock pays no dividends. Her broker says that the 
stock will be worth $20 per share in 2 years. 
What is the annual rate of return on this 
investment?
EXAMPLES
 Will invests $2000 in a bond trust that pays 9% 
interest compounded semiannually. His friend 
Henry invests $2000 in a certificate of deposit 
(CD) that pays 8.5% compounded continuously. 
Who has more money after 20 years, Will or 
Henry?
EXAMPLES 
 How long will it take for an investment to double 
in value if it earns 5% compounded continuously?
EXAMPLES
 What annual rate of interest compounded 
annually should you seek if you want to double 
your investment in 5 years?
EXAMPLES
 On­line problems

 More on­line examples

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