CHAPTER 5: COMPOUND INTEREST

INTRODUCTION

 Normally applied in investment.

 It is calculate based on the principal which changes every year (because based from the latest
balance).
 The interest due is added to the principal at the end of each interest period and thereafter earns
interest.
 Principal increase from time to time.

FORMULA

(i) FUTURE VALUE/ACCUMULATED VALUE/SUM, S

mt
 k k
S  P1  i
n
 S  P1   i and n  mt
 m m

(ii) COMPOUND INTEREST, I

I  S P

S  Future Value/Accumulated Value/Sum/ Total Amount/Mat urity Value (in RM)

P  Present Value/Discounted Value/Principal (in RM)
I  Compound Interest (in RM)
i  Periodic Interest Rate (in %)
n  Number of Interest Periods in the investment periods

TERMS

(a) Original Principal, P (in RM)

 The original amount invested.

(b) Annual Nominal Rate, k (in %)

 The interest rate for a year together with the frequency in which the interest is calculated in a
year.
 The rate of interest is usually stated as an annual interest rate.
 Case: (i) Compounded Annually  It means interest is calculated one time a year.
(ii) Compounded Semiannually  It means interest is calculated two times/twice a year.
(iii) Compounded Quarterly  It means interest is calculated four times a year.
(every 3 months)
(iv) Compounded Monthly  It means interest is calculated every month.
(v) Compounded Weekly  It means interest is calculated every week.
(vi) Compounded Daily  It means interest is calculated everyday.
(vii) Compounded Every 2 Months  It means interest is calculated every 2 month.
(viii) Compounded Every 4 Months  It means interest is calculated every 4 month.
 Example: Arief invest RM 10,000 for 10 years at 10% compounded semiannually.
k  10%  0.1

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(c) Interest Period, t (in years)
 Length of time in which interest is calculated.
 Example: Arief invest RM 10,000 for 10 years at 10% compounded semiannually.
t  10
(d) Frequency of Conversions, m
 The number of times interest calculated in a year.
 Case: (i) Compounded Annually  m 1
(ii) Compounded Semiannually  m  2
(iii) Compounded Quarterly  m4
(every 3 months)
(iv) Compounded Monthly  m  12
(v) Compounded Weekly  m  52
(vi) Compounded Daily  m  360
(vii) Compounded Every 2 Months  m  6
(viii) Compounded Every 4 Months  m  3
 Example: Arief invest RM 10,000 for 10 years at 10% compounded semiannually.
m2
(e) Periodic Interest Rate, i (in %)
 The interest rate for each interest periods.
 Example: Arief invest RM 10,000 for 10 years at 10% compounded semiannually.
k 10%
i   0.05  5%
m 2
(f) Number of interest periods in the investment period, n
 Number of times interest is calculated.
 Example: Arief invest RM 10,000 for 10 years at 10% compounded semiannually.
n  mt  2 10  20

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Example 1: Exercise 1:

Calculate the amount obtained for the following Calculate the amount obtained for the following
loans: loans:

(a) RM 1,300 with interest 9% compounded (d) RM 2,300 with interest 5% compounded
semiannually for 5 years. semiannually for 15 years.

Solution:
mt
 k
S  P 1  
 m
2 ( 5)
 0.09 
 13001  
 2 
 RM 2018.86

(b) RM 850 with interest 8% compounded (e) RM 1850 with interest 7.5% compounded
quarterly for 3.5 years. quarterly for 5.5 years.
Solution:
mt
 k
S  P1  
 m
4 ( 3 .5 )
 0.08 
 850 1  
 4 
 RM1121 .56

(c) RM 2,000 with interest 6.5% compounded (f) RM 2,500 with interest 4.5% compounded
monthly for 8 months. monthly for 18 months.

Solution:

mt
 k
S  P 1  
 m
 8 
12  
 0.065   12 
 20001  
 12 
 RM 2088.33

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Example 2: Exercise 2:

Bank D gives a loan of RM 10,000 to Fitri with
interest rate of 9.25% compounded semiannually.
Fitri has to settle the loan after 3 years.
(a) What is the amount Fitri has to pay to Bank
D?
OCBD Bank gives a loan of RM 15,000 to Suhana
with interest rate of 6.75% compounded
semiannually. Suhana has to settle the loan after 5
years.
(c) What is the amount Suhana has to pay to
OCBD Bank?

Solution:

mt
 k
S  P1  
 m
2 3 
 0.0925 
 10000 1  
 2 
 RM13116 .34
(d) Calculate the amount of interest charged.
(b) Calculate the amount of interest charged.

Solution:

I  S P
 13116 .34  10000
 RM3116 .34

Example 3 Exercise 3

Mr. Bala invested RM10,000 in a unit trust fund
that offers an interest of k% compounded monthly.
The amount accumulated in the fund after 10 years
was RM23,500. Find the amount of interest earned
by Mr. Bala and determine the value of k.
Julia deposited RM3,500 in a saving account at k%
compounded every 6 months. Determine the value
of interest earned and the value of k if the
accumulated value at the end of 3.5 years was RM
4,600.

Solution: Solution:

I=S-P

=23,500-10,000

=RM13,500

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 mt
 k
S  P 1  
 m
12 (10 )
 k 
23500  100001  
 12 
120
23500  k 
 1  
10000  12 
120
 k 
2.35  1  
 12 
k
120
2.35  1 
12
k
120
2.35  1 
12
k  120

2.35  1  12
k  8.57%

Example 4 Exercise 4

Nine years ago, Suhana saved RM10,000 in a
bank at interest rate of 4.5% compounded
quarterly. Today, she withdraws some amount of
money and the balance is RM14,059.16. Find the
amount of the withdrawal.
Haikal invested RM7,000 in an account that pays
11% compounded quarterly. Four and half years
later RMA was withdrawn from the account. Find
the value of A if the balance after withdrawal is
RM6,406.99.

Solution:

S = P(1 + i)n

= 10,000(1 + 0.045/4)4(9)

= 14,959.16

Balance  14,959.16  withdrawal

14,059.16  14,959.16  withdrawal
withdrawal  RM 900

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Example 5 Exercise 5

En. Fahmi opened an account for his child 5 years
ago that offered 5.65% compounded monthly with
a deposit of RM5000. Today, he plans to withdraw
RM6,000 from the account. What is the amount in
the account after 2 years of withdrawal?
En. Fahmi opened an account for his child 6 years
ago that offered 4.56% compounded quarterly with
a deposit of RM10,000. Today, he plans to
withdraw RM5,000 from the account. What is the
amount in the account after 2 years of withdrawal?

Solution:

S = P(1 + i)n

= 5,000(1 + 0.0565/12)12(5)

= RM6,627.81

Balance=6,627.81-6000=627.81

S = P(1 + i)n

= 627.81(1 + 0.0565/12)12(2)

=RM702.73