Business Mathematics 7: Compound Interest: Lecture Notes

Compound Interest
Present Value
Finding the Number of Years in a Loan
Finding the Interest Rate in a Loan
Nominal and Effective Rates
Exercises
Business Mathematics
7: Compound Interest
Lecture Notes
University of Santo Tomas- Senior High School
November 1, 2017
Lecture Notes 7: Compound Interest

Compound Interest
Present Value
Exercises
Overview:
1 Compound Interest
Business Concepts
Period Interest Rate
Manual Calculation of Compound Amount(Future Value) and
Compound Interest
Computation of Compound Amount (Future Value) and Compound
Interest
2 Present Value
3 Finding the Number of Years in a Loan
4 Finding the Interest Rate in a Loan
5 Nominal and Effective Rates
6 Exercises
Compound Interest
Present Value
Exercises
Interest
Interest is the rental fee charged by a lender to a business or an
individual for the use of money.

Compound Interest
Present Value
Exercises
Interest
Three Factors that Determine the Amount of Interest Charged:

1 Principal is the amount of money being borrowed or invested.
2 Rate is the percent of interest charged on the money per year.
3 Time is the length of time, expressed in days, months, or
years, of an investment or loan.

Compound Interest
Present Value
Exercises
Interest
Three Factors that Determine the Amount of Interest Charged:

1 Principal is the amount of money being borrowed or invested.
2 Rate is the percent of interest charged on the money per year.
3 Time is the length of time, expressed in days, months, or
years, of an investment or loan.
Compound Interest
Compound interest means that the interest is calculated more than
once during the time period of the loan.
Compound Interest
Present Value
Exercises
Concepts
Time Value of Money

Question: If you were owed 10, 000 pesos, would you rather have it
now or one year from now?

Compound Interest
Present Value
Exercises
Concepts
Time Value of Money

Compound Amount or Future Value

Compound amount is the total amount of principal and
accumulated interest at the end of a loan or an investment.

Compound Interest
Present Value
Exercises
Concepts
Time Value of Money

Compound Amount or Future Value

Compound amount is the total amount of principal and
accumulated interest at the end of a loan or an investment.
Present Amount or Present Value

An amount of money that must be deposited today at compound
interest to provide a specified lump sum of money in the future is
called present value.
Compound Interest
Present Value
Exercises
Period
Period is the amount of time that elapses between when interest
was last compounded and the next time it is compounded.
Formula:
Periods = mn
where m is the number of years and n is the number of periods per
year

Compound Interest
Present Value
Exercises
Example 1:
An investment made for 5 years at 12%
1 compounded annually then we would have (5 years × 1 period
per year ) 5 compounding periods.

Compound Interest
Present Value
Exercises
Example 1:
An investment made for 5 years at 12%
1 compounded annually then we would have (5 years × 1 period
per year ) 5 compounding periods.
2 compounded semiannually then we would have (5 years × 2
periods per year ) 10 compounding periods.

Compound Interest
Present Value
Exercises
Nominal Rate
Nominal rate is the annual rate.

The period interest rate is computed by dividing the yearly interest
rate by the number of periods per year that the interest is
compounded.

Compound Interest
Present Value
Exercises
Nominal Rate
Nominal rate is the annual rate.

The period interest rate is computed by dividing the yearly interest
rate by the number of periods per year that the interest is
compounded.
Formula:
Yearly interest rate or Nominal rate
Period interest rate = Number of interest periods per year
or
R
r=
n

Compound Interest
Present Value
Exercises
Example 2:
Find the period interest rate if the annual interest rate is 8% and
the interest is compounded quarterly.

Compound Interest
Present Value
Exercises
Example 2:
Find the period interest rate if the annual interest rate is 8% and
the interest is compounded quarterly.
Example 3:
Find the amount of the simple interest on a 2000 Korean won
investment at an annual rate of 4% for 3 years. What is the
compound interest if it is compounded yearly?

Compound Interest
Present Value
Exercises
MANUALLY CALCULATING COMPOUND

AMOUNT(FUTURE VALUE) AND COMPOUND
INTEREST
Example 4:
Kate invested 5, 000 pesos in a passbook savings account at 10%
interest compounded annually for 2 years. Manually calculate the
compound amount of the investment and the total amount of
compound interest Kate earned.

Compound Interest
Present Value
Exercises

INTEREST
Example 4:
Kate invested 5, 000 pesos in a passbook savings account at 10%
interest compounded annually for 2 years. Manually calculate the
compound amount of the investment and the total amount of
compound interest Kate earned.
Example 5:
Manually recalculate the compound amount and compound
interest from the previous example by using semiannual
compounding (two times per year). How much more interest would
Kate earn if the bank offered semiannual
Lecture Notes
compounding?
7: Compound Interest
Compound Interest
Present Value
Exercises
COMPUTING COMPOUND AMOUNT (FUTURE VALUE) AND

COMPOUND INTEREST
There are two methods on how to compute compound interest
problems:
1 Compound Interest Formula

Compound Interest
Present Value
Exercises
COMPUTING COMPOUND AMOUNT (FUTURE VALUE) AND

COMPOUND INTEREST
There are two methods on how to compute compound interest
problems:
1 Compound Interest Formula
2 Compound Interest Tables (For Self-study)

Compound Interest
Present Value
Exercises
Compounding Periods per Year

Interest Compounded Compounding Periods per Year
Annually (every year) 1
Semiannually (every 6 months) 2
Quarter (every 3 months) 4
Monthly (every month) 12
Daily (every day) 365
Continuously infinite

Compound Interest
Present Value
Exercises

INTEREST
Formula
Compound interest = Compound amount − Principal
Ic = F − P
(F = P + Ic )
(P = F − Ic )

Compound Interest
Present Value
Exercises
CALCULATING COMPOUND AMOUNT (FUTURE VALUE) BY

USING THE COMPOUND INTEREST FORMULA
mn
R

F =P 1+
n
where
F =Compound amount
P =Principal amount
R = Interest rate
m =number of years
n =number of (compounding) periods per year

Compound Interest
Present Value
Exercises
Example 6:
Use the compound interest formula to calculate the compound
amount of 5, 000 pesos invested at 10% interest compounded
semiannually for 3 years.

Compound Interest
Present Value
Exercises
Example 7:
Use the compound interest formula to calculate the compound
amount of 3, 000 CNY (Chinese yuan) invested at 8% interest
compounded quarterly for 5 years.
Try this!
Solve for the compounding periods and period interest rate (%)
given the following:
Terms of Investment Annual Rate (%) Interest Compounded
3 years 13 annually
5 years 16 quarterly
12 years 8 semiannually
6 years 18 monthly

Compound Interest
Present Value
Exercises
Present Value Formula

F
P= mn
R
1+ n
where
F =Compound amount
P =Principal amount
R = Interest rate
m =number of years

Compound Interest
Present Value
Exercises
Example 8:
Use the present value formula to calculate the present value of
3, 000 Cambodian riel if the interest rate is 16% compounded
quarterly for 6 years.
Example 9:
Sam and Rosa Alonso want to accumulate 30, 000 Cuban peso, 17
years from now as a college fund for their baby son, Michael. Use
the present value formula to calculate how much they must invest
now at an interest rate of 8% compounded semiannually to have
30, 000 Cuban peso in 17 years.

Compound Interest
Present Value
Exercises

Formula:
F
log(1+ R ) P log PF
n
m= or m = ÷n
n log 1 + R
n
where
F =Compound amount
P =Principal amount
R = Interest rate
m =number of years

Compound Interest
Present Value
Exercises
Example 10:
How long will it take Php 3, 000 to accumulate to Php 3, 500 in a
bank savings account at 0.25% compounded monthly?

Compound Interest
Present Value
Exercises
Finding the Rate

Formula: s 
F t
R = n − 1
P
where
t = mn
F =Compound amount
P =Principal amount
R = Interest rate
m =number of years
t =number of periods
Compound Interest
Present Value
Exercises
Example 11:
If 3, 050 pesos accumulates to 8, 660 pesos in 5 years, what is the
interest rate compounded monthly?
Example 12:
Find the rate compounded quarterly if 745 USD accumulates to
786 USD in 3 years and 9 months.

Compound Interest
Present Value
Exercises
3 Rates:
1 Period Interest rate (or Periodic rate (r ))
2 When the conversion period (or compounding period) is other

than a year, the stated annual rate of interest is called
nominal rate (R).
3 When the conversion period (or compounding period) is one
year, the annual rate of interest is called effective rate (e), the
rate actually earned in a year.

Compound Interest
Present Value
Exercises
Nominal Rate Formula:

h√ i
n
R=n 1+e−1
Effective Rate Formula:

n
R

e= 1+ −1
n
where
R = Nominal rate
n = Number of (compounding) periods per year
e = Effective Rate

Compound Interest
Present Value
Exercises
Example 13:
What nominal rate compounded monthly, will yield the effective
rate 4%?
Example 14:
When interest is compounded monthly, find the effective rate
corresponding to the nominal rate 3%.

Compound Interest
Present Value
Exercises
Remarks:
1 When interest is compounded annually, the effective rate (e)
is equal to the nominal rate (R), but when it is compounded

more than once a year, the effective rate is higher than the
nominal rate.
2 When comparing two different rates compounded at different
conversion periods per year (n), we compute their respective
effective rates.
Example 15:
Which yields more interest, (4 14 %, n = 4) or (5%, n = 12)?

Compound Interest
Present Value
Exercises
Exercises:
1. As a savings plan for college, when their son Bob was born,
Ann and Ben deposited 10, 000 pesos in an account paying
8% compounded annually. How much will the account be
worth when Bob is 18 years old?
2. Sharon invested 3, 000 European euro at the Horizon Bank at
6% interest compounded quarterly.
1 What is the annual percentage yield of this investment?
2 What will Sharon’s investment be worth after 6 years?
3. A certain animal husbandry program has a flock of sheep that

increases in size by 15% every year. If there are currently 48
sheep, how many sheep are expected to be in the flock in 5
years? Round to the nearest whole sheep.
Compound Interest
Present Value
Exercises
Exercises:
4. The rate of bacteria growth in a laboratory experiment was

measured at 16% per hour. If this experiment is repeated and
begins with 5 grams of bacteria, how much bacteria should be
expected after 12 hours? Round to the nearest tenth of a
gram.
5. The ABC Motorcycle Company invested 250, 000 Australian
dollars at 4.5% compounded monthly to be used for the
expansion of their manufacturing facilities. How much money
will be available for the project in 3 12 years?
6. Quin-Star Airlines intends to pay off a 20, 000, 000 Nepalese
rupee corporate bond issue that comes due in 4 years. How
much must the company set aside now at 6% interest
compounded monthly to accumulate the required amount of
money? Lecture Notes 7: Compound Interest
Compound Interest
Present Value
Exercises
Exercises:
7. Apin placed 34, 400 pesos in an investment firm. If this

amounted to 42, 200 pesos after 4 years and 8 months, find
the rate used if it is converted monthly.
8. When is 13, 970 Australian dollars due if its present value is
10, 475 Australian dollars when money is worth 9%
compounded monthly?
9. Toting deposited 17700 European euros in a savings bank on
June 30, 2005 at a rate of 14% converted quarterly. How
much will he get if he withdraws all his deposits on December
30, 2012?
10. When is 13, 970 Argentine pesos due if its present value is
10, 475 Argentine pesos when money is worth 9%
compounded monthly?
Compound Interest
Present Value
Exercises
R. Brechner and G. Bergeman Contemporary Mathematics for Business

and Consumers, 7th Edition, (2015). Cengage Learning; ISBN:
9781285189758.
A. Bluman Business Math Demystified, (2006). USA:McGraw-Hill.
F.M. Capitulo Mathematics of Investment (A simplified Approach).

Compound Interest
Present Value
Exercises
Quote:
“Compound interest is the eighth wonder of the world. He
who understands it, earns it. He who doesn’t, pays it."
- Albert Einstein

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Compound Interest

University of Santo Tomas- Senior High School

Lecture Notes 7: Compound Interest

Lecture Notes 7: Compound Interest

Three Factors that Determine the Amount of Interest Charged:

Lecture Notes 7: Compound Interest

Three Factors that Determine the Amount of Interest Charged:

Time Value of Money

Lecture Notes 7: Compound Interest

Time Value of Money

Compound Amount or Future Value

Lecture Notes 7: Compound Interest

Time Value of Money

Compound Amount or Future Value

Present Amount or Present Value

Lecture Notes 7: Compound Interest

Lecture Notes 7: Compound Interest

Lecture Notes 7: Compound Interest

Period Interest Rate

Lecture Notes 7: Compound Interest

Period Interest Rate

Lecture Notes 7: Compound Interest

Lecture Notes 7: Compound Interest

Lecture Notes 7: Compound Interest

MANUALLY CALCULATING COMPOUND

Lecture Notes 7: Compound Interest

MANUALLY CALCULATING COMPOUND

COMPUTING COMPOUND AMOUNT (FUTURE VALUE) AND

Lecture Notes 7: Compound Interest

COMPUTING COMPOUND AMOUNT (FUTURE VALUE) AND

Lecture Notes 7: Compound Interest

Compounding Periods per Year

Lecture Notes 7: Compound Interest

MANUALLY CALCULATING COMPOUND

Lecture Notes 7: Compound Interest

CALCULATING COMPOUND AMOUNT (FUTURE VALUE) BY

Lecture Notes 7: Compound Interest

Lecture Notes 7: Compound Interest

Lecture Notes 7: Compound Interest

Present Value Formula

Lecture Notes 7: Compound Interest

Lecture Notes 7: Compound Interest

Finding the Number of Years in a Loan

Lecture Notes 7: Compound Interest

Lecture Notes 7: Compound Interest

Finding the Rate

Lecture Notes 7: Compound Interest

2 When the conversion period (or compounding period) is other

Lecture Notes 7: Compound Interest

Nominal Rate Formula:

Effective Rate Formula:

Lecture Notes 7: Compound Interest

Lecture Notes 7: Compound Interest

is equal to the nominal rate (R), but when it is compounded

Lecture Notes 7: Compound Interest

3. A certain animal husbandry program has a flock of sheep that

4. The rate of bacteria growth in a laboratory experiment was