Compound Interest

Money working for you!

Definition
Compound interest is where the
interest is calculated not only on the
principal but on all the previous interest
as well.
Example
If $5000 was invested at 6% compounded semi-annually for
two years, the amount (A) after each compound period is:

The first compounding The third compounding period:

period: A = (5000 x 1.03 x 1.03) x 1.03
A = 5000 x 1.03 = 5304.5 x 1.03
= 5150 = 5463.64

The second compounding The fourth compounding period:

period: A = (5000 x 1.03 x 1.03 x 1.03) x 1.03
A = (5000 x 1.03) x 1.03 = 5463.64 x 1.03
= 5150 x 1.03 = 5627.54
= 5304.50
The Equation
Looking at the fourth conversion period:
A = 5000 x 1.03 x 1.03 x 1.03 x 1.03
A = 5000 x 1.034
A = 5000(1.03)4
A = 5000(1 + 0.03)4
or
A = Principal (1 + i)n
A = P(1 + i)n
The Future Value Equation

This will calculate the future value of an investment or

loan if the interest is compounded depending on:

P – the principal
i – the interest rate per compounding period
n – the number of compounding periods

A = P(1 + i)n
 Example
How much would a person need to invest today to have a final amount
of $1000 in one year? The investment is at 3% compounded quarterly.
i = 0.03 ÷ 4
= 0.0075
4 quarters
Today 1 quarter 2 quarters 3 quarters or 1 year

977.83 985.17 922.56 1000 1000

(1 + 0.0075) (1 + 0.0075) (1 + 0.0075) (1 + 0.0075)

=970.55 =977.83 =985.17 = 992.56

$1000 three months from now

is only worth $992.56 today
The Equation
Looking at the “Today” calculation:
P = 1000 ÷ (1.0075) ÷ (1.0075) ÷ (1.0075) ÷ (1.0075)
P = 1000 ÷ (1.0075)4
P = 100 0 4
( 1.0 0 75 )
Or
A m ount
P=
(1  i ) n
The Present Value Equation

This will calculate the present value of an investment or

loan if the interest is compounded depending on:

P – the principal
i – theAinterest
m ount rate per compounding period
nP– the number
n of compounding periods
(1  i )