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Compound Interest

Compound Interest

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Published by: bhunkri on Feb 12, 2009
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07/19/2013

 
1)
Compound Interest:
For interest compounded a certain number of times,
n
, per year, such asmonthly or quarterly, the formula is:
= Total time in years
n
= Number of compounding periods per year (note that the total number of compounding periods is )
=  Nominal annual interest rateexpressed as a decimal. e.g.: 6% = 0.06
2)find the
interest rate
per period:2) find the
number of interest periods
required to achieve your goal:
3)Doubling
The number of time periods it takes for an investment to double in value is
Shortcut to Calculation.Here is an Example to solve easily:
What will Rs.1500 amount to in three years if it is invested in 20% p.a. compoundinterest, interest being compounded annually?
 
(1)2400 (2)2592 (3)2678 (4)2540Correct Answer -
(2)Solution:
The usual way to find the compound interest is given by the formula A = .In this formula, A is the amount at the end of the period of investmentP is the principal that is investedr is the rate of interest in % p.aAnd n is the number of years for which the principal has been invested.In this case, it would turn out to be A =So great. How do you find the value of the above term? It is time consuming.Let us look at another alternative.What happens in compound interest?Interest is paid on interest.In the first year, interest is paid only on the principal. That is very similar to simple interest.However, from the second year onwards things change. In the second year, you pay interest onthe principal and also interest on interest.
Therefore, the Amount at the end of 2
nd
year in compound interest can be computed asfollows1 * Principal + 2* Simple interest on principal + 1 * interest on interest.Similarly, if you were to find the Amount at the end of 3 years in compound interest use thefollowing method1*Principal + 3 * Simple interest on principal + 3 * interest on interest + 1 * interest oninterest on interestLet us see how it works in our example
.The principal is Rs.1500. The rate of interest is 20%. Therefore, the simple interest on principalis 20% of 1500 = Rs.300The interest on interest = 20% interest on the interest of Rs.300 = 20% of Rs.300 = Rs.60.Interest on interest on interest = 20% of Rs.60 = Rs.12. Now add all theseAmount at the end of 3 years = 1*Principal + 3 * Simple interest on principal + 3 * interest on
 
interest + 1 * interest on interest on interest= 1500 + 3*300 + 3*60 + 1*12 = 1500 +900 + 1800 +12 = 2592.You will get the same answer if you had used the formula. However, the calculation in this casewas far easier than using the formula.
Try out the same method for four and five years and remember the 1-2-1, 1-3-3-1, 1-4-6-4-1etc method which you can use comfortably in the exam.
Simple and compound interest testQuestion 1 of 25compound interest on Rs. 480 at 16 2/3% per annum for 2 3/4 years is:
 
1. Rs. 2602. Rs. 2523. Rs. 2554. Rs. 263.33Mark for revision | Unmark Question 2 of 25Dhiraj
a part of Rs. 8000 at 4% p.a. & the remainder at 5% per year. His annual incomefrom the
is Rs. 350. How much has he invested at each rate? (in rupees)1. 3000, 4000

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