Compounding More

Than Once A Year

Important Terms to Remember
• Conversion or interest period – time
between successive conversions of interest.
• Frequency of conversion (m) – the
number of conversion periods in one year.
(𝒎)
• Nominal rate (𝒊 ) – annual rate of interest
Important Terms to Remember
• Rate (j) of interest for each conversion period
𝒊(𝒎)
𝒋=
𝒎
• Total number of periods, n
𝒏 = 𝒎𝒕 = 𝑓𝑟𝑒𝑞𝑢𝑒𝑛𝑐𝑦 𝑜𝑓 𝑐𝑜𝑛𝑣𝑒𝑟𝑠𝑖𝑜𝑛 𝑥 (𝑡𝑖𝑚𝑒 𝑖𝑛 𝑦𝑒𝑎𝑟𝑠)
Here are some examples of nominal rates and
the corresponding frequencies of conversion and
interest rate for each period:
 𝑖 𝑚 = Nominal rate 𝑚 = Frequency of 𝑗 = Interest rate per
One conversion period
(Annual interest rate) conversions conversion period
2% compounded
0.02
annually; 1 = 0.02 = 2% 1 year
𝑖 (1) = 0.02 1

2% compounded semi-
0.02
annually; 2 = 0.01 = 1% 6 months
𝑖 (2) = 0.02 2
2% compounded
0.02
quarterly; 4 = 0.005 = 0.5% 3 months
𝑖 (4) = 0.02 4

2% compounded
0.02
monthly; 12 = 0.0016 = 0.16% 1 month
𝑖 (12) = 0.02 12

2% compounded daily; 0.02

365 1 day
𝑖 (365) = 0.02 365
Maturity Value, Compounding m times a year
𝒎 𝒎𝒕
𝒊
𝑭=𝑷 𝟏+
𝒎
Where
𝐹 = maturity or future value
𝑃 = principal / present value
(𝑚)
𝑖 = nominal rate of interest (annual rate of interest)
𝑚 = frequency of conversion
𝑡 = term / time in years
Examples
1. Find the maturity value and interest if ₱10,000 is
deposited in a bank at 2% compounded quarterly for 5
years. 𝐹 = ? 𝐼 =?
Solution 𝑚 𝑚𝑡
𝑖
𝐹 =𝑃 1+
Given: 𝑚
0.02 4(5)
𝑃 = ₱10,000 𝐹 = 10,000 1 +
(4) 4
𝑖 = 2% 𝑭 = ₱𝟏𝟏, 𝟎𝟒𝟖. 𝟗𝟔
𝑚=4 𝐼 =𝐹−𝑃
𝑡 = 5 𝑦𝑒𝑎𝑟𝑠 𝐼 = 11,048.96 − 10,000
𝑰 = ₱𝟏, 𝟎𝟒𝟖. 𝟗𝟔
Examples
2. Yukee borrows ₱50,000 from Sir Aldrich and promises
to pay the principal and interest at 12% compounded
monthly. How much must she repay after 6 years?
Solution
Given: 𝐹 =?
𝑚𝑡
𝑃 = ₱50,000 𝑖 𝑚

(12)
𝐹 =𝑃 1+
𝑖 = 12% 𝑚
0.12 12(6)
𝑚 = 12 𝐹 = 50,000 1 +
12
𝑡 = 6 𝑦𝑒𝑎𝑟𝑠 𝑭 = ₱𝟏𝟎𝟐, 𝟑𝟓𝟒. 𝟗𝟕
Present Value at Compound Interest
𝒎 −𝒎𝒕
𝒊
𝑷=𝑭 𝟏+
𝒎
Where
𝐹 = maturity or future value
𝑃 = principal / present value
(𝑚)
𝑖 = nominal rate of interest (annual rate)
𝑚 = frequency of conversion
𝑡 = term / time in years
Example
3. Find the present value of ₱50,000 due in 4 years if
money is invested at 12% compounded semi-annually.
Solution
Given
𝐹 = ₱50,000
𝑃 =?
𝑡 = 4 𝑦𝑒𝑎𝑟𝑠 𝑚 −𝑚𝑡
𝑖
(2) 𝑃 =𝐹 1+
𝑖 = 12% 𝑚
𝑚=2 0.12 2(4)
𝑃 = 50,000 1 +
2
𝑷 = ₱𝟑𝟏, 𝟑𝟕𝟎. 𝟔𝟐
Finding Interest Rate and Time in Compound Interest
Example
4. How long will it take ₱3,000 to accumulate ₱3,500 in a
bank saving account at 0.25% compounded monthly?
Solution 𝑡 =?
𝑚𝑡
𝑃 = ₱3,000 𝐹 =𝑃 1+
𝑖 𝑚

𝑚
𝐹 = ₱3,500 12(𝑡)
0.0025
𝑖 (12) = 0.25% 3,500 = 3,000 1 +
12
𝑚 = 12 3,500 0.0025 12(𝑡)
= 1+
3,000 12
Finding Interest Rate and Time in Compound Interest
Example
4. How long will it take ₱3,000 to accumulate ₱3,500 in a
bank saving account at 0.25% compounded monthly?
12(𝑡)
Solution log
3,500
= log 1 +
0.0025
3,000 12
𝑃 = ₱3,000 0.0025
log 1.166667 = 12𝑡 log 1 +
12
𝐹 = ₱3,500 0.0025
log 1.166667 12𝑡 log 1+ 12
(12) =
𝑖 = 0.25% 12 log 1+
0.0025
12 log 1+
0.0025
12 12
𝑚 = 12 𝒕 = 𝟔𝟏. 𝟔𝟕 𝒚𝒆𝒂𝒓𝒔
Finding Interest Rate and Time in Compound Interest
Example
5. At what nominal rate compounded semi-annually will
₱10,000 accumulate to ₱15,000 in 10 years?
𝑖 (2) =?
Solution
𝑚𝑡
𝑖𝑚
𝑃 = ₱15,000 𝐹 =𝑃 1+
𝑚
𝐹 = ₱10,000 𝑖 2 20
15,000 = 10,000 1 +
𝑡 = 10 𝑦𝑒𝑎𝑟𝑠 2
20
15,000 𝑖2
𝑚=2 = 1+
10,000 2
Finding Interest Rate and Time in Compound Interest
Example
5. At what nominal rate compounded semi-annually will
₱10,000 accumulate to ₱15,000 in 10 years?
Solution
1
𝑖2
𝑃 = ₱10,000 1.5 20 = 1 +
2
𝐹 = ₱15,000 1
1.5 20 − 1 =
𝑖2
2
𝑡 = 10 𝑦𝑒𝑎𝑟𝑠 1
[ 1.5 20 −1](2) = 𝑖 2
𝑚=2 𝒊 𝟐 = 𝟎. 𝟎𝟒𝟏𝟎 𝒐𝒓 𝟒. 𝟏𝟎%
Effective Rate, 𝒊(𝟏)
Effective rate is the rate compounded annually that
will give the same compound amount as a given nominal
rate; denoted by 𝑖 (1) .
𝐹1 = 𝐹2

1 (1)𝑡 𝑚 𝑚𝑡
𝑖 𝑖
𝑃 1+ = 𝑃 1+
1 𝒎
𝑚
𝒎
(𝟏)
𝒊
𝒊 = 𝟏+ −𝟏
𝒎
Effective Rate, 𝒊(𝟏)
Example
6. What effective rate is equivalent to 10% compounded
quarterly?
Solution 𝑖 (1) = ?
Given: 𝑖 4 4
𝑖 (1) = 1 + −1
𝑖 (4) = 10% 4
4
(1) 0.10
𝑚=4 𝑖 = 1+ −1
4
𝒊(𝟏) = 𝟎. 𝟏𝟎𝟑𝟖𝟏𝟑 𝒐𝒓 𝟏𝟎. 𝟑𝟖%

𝑒𝑓𝑓𝑒𝑐𝑡𝑖𝑣𝑒 𝑟𝑎𝑡𝑒 𝑖𝑠 𝑎𝑙𝑤𝑎𝑦𝑠 ℎ𝑖𝑔ℎ𝑒𝑟 𝑡ℎ𝑎𝑛 𝑡ℎ𝑒 𝑛𝑜𝑚𝑖𝑛𝑎𝑙 𝑟𝑎𝑡𝑒