Compound

Interest

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 Compound Interest
 Simple interest is generally used for loans of one year or less.
For loans of more than one year, the interest paid on the money
borrowed usually use compound interest.
 Compound interest is interest calculated not only on the
original principal, but also on any interest that has already
been earned.
…the calculation of interest over the life
of the loan or investment

Let’s assume that the interest rate is 10% pa.

Example: Principal + prior period interest = $1100.00
Interest is now calculated on $1100.00

Principal(Compounded) * 0.10 = $110.00

New P $1210.00 to start next period
 Graphically
Amount Interes Interes Interes Interes
$1000 t t t t

133.1
1331
121 121
1210
110 110 110
1100
100 100 100 100
1000

Compounding Compounding Compounding Compounding

Period Period Period Period
0 1 2 3 4
Time(Years)
Compounding Frequencies and Periods
Frequency No. per Year Period
Annually 1 1 year
Semiannually 2 6 months
Quarterly 4 3 months
Monthly 12 1 month
Daily 365 1 day

Interest Times Credited Rate per compounding

Period
Credited per year period

Annual year 1 R
R
Semiannual 6 months 2 2
R
Quarterly quarter 4 4
R
Monthly month 12 12
 Compound Interest Formula
Nominal or Annual Rate (j)
Number of compounding per year (m)
Periodic Rate per period (i )
Total Number of Period (n)
To Determine n

*
Time(Years) # of Compounding Frequencies p.a.(m)

To Determine i

Annual Interest Rate( j )

# of Compounding Frequencies p.a. (m)
 Formula
 Future Value - …is the compounded amount and is the
FINAL amount of the loan or investment at the end of the
last period!
 Present value - ...is the value of a loan or investment
TODAY!

FV = PV(1 + i)n
Where…

PV= Present Value(Principal)

i = rate per period
n = number of periods
 Example
 Find the amount to which $1500 will grow if compounded
quarterly at 6.75% interest for 10 years.
 Solution:
 Use future value formula

FV = PV(1 + i)n
 0.0675
Here PV = $1500, i = , n = 10  4
4

FV = 1500(1+0.016875)40

FV = 2929
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