MODULE 10: COMPOUND INTEREST 2

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 COMPOUND INTEREST
Linear Interpolation – finding the rate
Example 1.) At what rate compounded quarterly will P 57,500 accumulate to P 90,000 for 3 years?

Given: P = P 57,500 F = P 90,000 t = 3yearsm = 4 n = txm = 3 years x 4 = 12 r=?

To solve for r, we have to derive it’s formula from the main formula
First, to solve for i:
F = P(1+i)n
F = P (1 + i)n
P P
(1 + i)n = F/P
((1 + i)n = F/P)1/n 1 + i = (F/P) 1/n
Second, to solve for r
i = (F/P) 1/n – 1 i = (F÷P) (1÷n) - 1
i = r/m to get the formula of r, multiply both sides by m,
r=ixm

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 COMPOUND INTEREST
Linear Interpolation – finding the rate
Example: At what rate compounded quarterly will P 57,500 accumulate to P 90,000 for 3 years?

Given: P = P 57,500 F = P 90,000 t = 3yearsm = 4 n = txm = 3 years x 4 = 12 r=?

Solve first for i

i = (F/P)1/n – 1
= (90000/57500)^(1/12) – 1
i = 0.038041115 take note that you have to used all the digits for i
since this is not yet the final answer
To solve for r
r=ixm
= 0.038041115 x 4
= 0.152164459 x100 since this will be our final answer, change to percent then
r = 15.22% round off to 2 decimal places.

Example 2.) What rate compounded semi-annually is needed to be able for P 90,000 earn an interest of P 40,000 for
6 years? F = P + I Given: P= P 90,000 I= P 40,000 F= P 130,000
t=6 yrs m=2 n=6 yrs x 2 = 12

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COMPOUND INTEREST

SAMPLE PROBLEMS TO SOLVE

1.) At what rate compounded quarterly will P 200,000 earn an interest of P 190,000 for 4.5 years?

2.) What rate compounded semi-annually will P 250,000 become P 400,000 after 7 years?

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 COMPOUND INTEREST
Linear Interpolation – finding time
Example 1.) When will P 87,500 accumulate to P 120,000 at 9.6% compounded monthly?

Given: P = P 87,500 F = P 120,000 r = 9.6% m = 12 i=r/m = 9.6%/12= 0.8% (.008) t=?

To solve for n, we have to derive it’s formula from the main formula
First, to solve for n:
F = P(1+i)n
F = P (1 + i)n
P P
(1+i)n=F/P
(1+i)n=F/P
(1+i) (1+i)
n=log F/P
log(1+i)
To solve for t, n = t x m, divide both sides by m
t=n/m

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 COMPOUND INTEREST
Linear Interpolation – finding time
Example 1.) When will P 87,500 accumulate to P 120,000 at 9.6% compounded monthly?
Given: P = P 87,500 F = P 120,000 r = 9.6% m = 12 i=r/m = 9.6%/12= 0.8% (.008) t=?
Solution:
n = log F/P
log (1+i)
= log (120000/87500)
log(1+.008)
n = 39.63933542 take note that you have to used all the digits for n
since this is not yet the final answer
t = 39.6393354214
12
t = 3.30years since this is a final answer, round off to 2 decimal places
and expressed your answer in years

Example 2.) How long will it take to double an investment if invested at 9.5% compounded semi-annually?

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COMPOUND INTEREST
SAMPLE PROBLEMS TO SOLVE

1.) When will P 175,000 accumulate to P 220,000 at 8.66% compounded quarterly?

2.) How long will it take for an investment of P 250,000 earn an interest of P 250,000 at 9.85%
compounded annually?

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COMPOUND INTEREST

EQUIVALENT RATES

Equivalent rates are rates which will give the same compound amount after one year. The
formula can be derived from the compound amount formula F=P(1+i)n.

To derived the formula, we will simply compare 2 “(1+i)n”, which means

(1+i)n =(1+i)n

but since this will be good for only one year, we will simply use m as our exponent
(1+j/m)m =(1+j/m)m
to identify the 2 formulas, we need to use numbers
(1+j1/m1)m1 =(1+j2/m2)m2
to solve for equivalent rate, we have to derived the formula for j 1

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COMPOUND INTEREST

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COMPOUND INTEREST
PROBLEMS:
1.) What rate compounded quarterly is equivalent to 10% compounded semi-annually?
Given: j1=? m1=4 j2=10% (.10) m2=2
To solve: j1=4x((1+.10÷2)(2÷4)-1)
j1=0.098780306 change to percent then round off to 2 decimal places
j1=9.88%

2.) What rate compounded monthly is equivalent to 9.5% compounded annually?

3.) What rate compounded semi-annually is equivalent to 8% compounded monthly?

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COMPOUND INTEREST
NOMINAL AND EFFECTIVE RATES

Nominal rates are rates which are compounded more than once a year while Effective rates are
rates which are compounded only once a year. Nominal rate is being represented by “j” while
effective rate is represented by “w”.

To derived the formula for w, we will simply compare the 2, which means
1+w =(1+j/m)m

the formula for w will be w = (1+j/m)m – 1

To derived the formula for j, we will again compare the 2, which means
(1+j/m)m = 1+w

the formula for j will be j=m[(1+w)1/m-1]

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COMPOUND INTEREST
PROBLEMS:
1.) What rate compounded quarterly is equivalent to 10% effective rate?
Given: j=? m=4 w=10% (.10)
To solve: j=4x((1+.10)(1÷4)-1)
j=0.096454756 change to percent then round off to 2 decimal places
j=9.65%
2.) What effective rate is equivalent to 9.5% compounded semi-annually?
Given: w=? j=9.5% (.095) m=2
To solve: w=(1+.095÷2)2-1
w=0.09725625 change to percent then round off to 2 decimal places
w=9.73%
3.) What rate compounded semi-annually is equivalent to 8% effective rate?

4.) What effective rate is equivalent to 10.45% compounded monthly?

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Any Questions

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