CHAPTER THREE: COMPOUND INTEREST

3.1 Definition:
A capital is said to be placed at compound interest when at the end of the first period, the
interest produced is added to the capital in other to produce its own interest for the next
period and in this light at the end of each of any other period.
The interest produced will depend on the duration or period which can be annual, semi annual,
quarterly or even monthly. The number of periods will be denoted n.
The interest will also depend on the rate for 1 F I which is the rate per hundred divided by 100
That is to say i=r/100
Example : What will be the total amount in an account if 200 000F is placed for 3yrs at a
compound interest rate of 6%.
yrs Capital at the start of the period Interest produced Capital obtained at the
during the year end of the year
1 200 000 200 000*.06=12000 212000
2 212000 212000*.06=12720 224720
3 224720 224720*.06=13483.2 238203.2

3.2 Acquired Value

Yrs Capital placed Interest for the Capital at the end of the period
at the start period
1 C Ci C+Ci=C(1+i)
2 C(1+i) C(1+i)i C(1+i)+C(1+i)i=C(1+i)2
3 C(1+i)2 C(1+i)2i C(1+i)2+C(1+i)2i=C(1+i)3
4 C(1+i)3 C(1+i)3i C(1+i)3+C(1+i)3i =C(1+i)4

n-1 C(1+i)n-2 C(1+i)n-2i C(1+i)n-2+C(1+i)n-2i = C(i+i)n-1

n C(1+i)n-1 C(1+i)n-1i C(1+i)n-1+C(1+i)n-1i=C(1+i)n

A= C(1+i)n
Example 1: TAMBI invested the sum of 500 000frs in a credit union account that yields interest at the rate
of 5% p.a. how much will he collect at the end of the 6th year.

Exp 2: Example; a capital of 100 000frs is invested at a compound interest rate of 6% p a

for a duration of 3 years, Calculate ;
a— the acquired value A
b—the cumulative interest earned for the period.
NB: The acquired value of a certain amount invested at compound interest but on a duration which
is not an entire year that is to say a fraction of a year is involved can be calculated using three
methods.

THE USE OF THE RATIONAL SOLUTION

The rational solution is used when the duration of an investment of a given sum is
fractional. An example of a fractional duration is ; 2 years 5 months.
The rational solution involves the use of the general formular for the acquired value ( A )
and the use of the simple interest formular for the fractional part. The formular is stated as
follows ;
A=C( 1+i)n ( 1+im)
12
Components of the formular--- C - capital
I - interest rate per 1 franc
n - Whole part of duration
m- fractional part of duration
example3; determine the future value of 100 000frs at the rate of 6% p a for a period of 6 years 5
months using the rational solution.

USING THE COMMERCIALSOLUTION

This approach entails the use of the formularbelow;
A = C ( 1 + I ) n ( 1 + I )m/12.
Example 4 ; using the commercial solution determine the future value of 100 000frs invested at
the rate of 6 % for the period of 6 years 5 months.

Likewise the acquired value can be calculated using the formular

A= c(1+i)nm/12
Exmpl if the duration is 3yrs 4months, nm/12 = 3 = 3.33333
Considering the previous exercise, the Acquired value will be
A= 100 000(1.06)6.4166666= 145338F

6.A capital of 200000frs is placed at compound interest. The interest is calculated at an annual rate of 12%
and was placed for 9years 3 months. Calculate the acquired value using 3 solutions

Method one ( rational solution)

This first method involves the calculation of the acquired value after 9 years (the whole years) and then
considering this as the capital to be used to calculate the acquired value for the remaining months but this
time around using the simple interest formula as follows.
A= C(1+i)n(1+mi/12) where n is the whole years and m the number of months
9
A= 200 000(1.12) (1+3*0.12/12)= 571254.22

OR
-acquired value for the first 9 years=200000(1.12)9=554615.75frs
-acquired value for the remaining three months considering the previous acquired value as capital is given
by C + C r t/1200= 554615.75 + 554615.75*3*12/1200= 571254.2frs

Method two
Interpolation can be done from financial table 1 between the acquired value after 9 years and the acquired
value after 10 years. The required acquired value is that between this 9 and 10. Next the difference
between the two acquired values is calculated. The difference signify the interest yielded during the 10th
year. A fraction of this difference is then calculated and added to the acquired value after 9 years.
Acquired value after 9 years= 200000(1.12)9=554615.75frs
Acquired value after 10 years= 200000(1.12)10=621169.64frs
Acquired value after 9years 3months= 554615.75+3/12(621169.64-554615.75)=571254.22frs

Method three (commercial solution)

In this method (commercial solution), the duration is considered to be a mixed fraction which can be
expressed as a decimal as follows
A= C(1+i)n(1+i)m/12

Acquired value= C(1.12)9(1.12)3/12=200000(1.12)9(1.12)3/12=570554frs

OR the acquired value= 200000(1.12)9.25=570554frs

N.B:The acquired values produced after any period follows a geometric progression with common
ratio (1+r) i.e Cm=Cn(1+r)m-n

Expl; Fuh Laura invested an amount X in BICEC at a compound interest rate of 5%. If her acquired value
after 9 years is 1178973.85frs, Calculate the acquired value after 12 years.

3.3 CALCULATION OF INTEREST

The interest I= acquired value – capital
I= c(1+r)n - c
I=c[(1+r)n-1]

Likewise, considering table 1 above it will be realized that the interest produced during the different
years form a series in geometric progression with common ratio r=(1+i) and first term a=Ci
We can deduce the sum of compound interest yielded. We know that the sum of
numbers in GP is given by
 −1
=
−1
( )
Sn= ( )

(1 + ) − 1
=

The i will cancel out each other

= ⟨(1 + ) − 1⟩

Expl. A capital of 500 000F is invested for 6yrs at a compound interest rate of 5%. Calculate the total
interest yielded during the first three years as well as the total interest yielded during the entire six years.

N.B Since the interest produced during the different years are in a GP with common ratio (1+i), it implies
that Im=In(1+i)m-n
Where Im is the interest produced during a particular year m and In the interest produced during the year n.
The interest produced during a particular year can as well be related to the capital as follows

In=c(1+i)n-1i

Example 1:A capital is invested at compound interest. The interest produced during the fourth
year is equal to 1786524 and the interest produced during the sixth year is equal to 2007378frs.
Calculate the rate of the interest and the capital invested.

Example 2:A capital is invested at a rate r for eight years. The ratio of the total interest produced
during the first three years to the total interest produced within the last three years is 0.635228.
determine the investment rate

Example 3:Expl ; NGUM invested an amount x at a rate of 7% in BICEC bank the interest produced
during the fifth year is 5000frs.calculate the interest produced during the eleventh year

The acquired value can as well be read from the financial table 3. This is done by reading the value of
(1+i)n which when multiplied by C will give the acquired value.

Expl: Use the financial table to calculate the acquired value of a capital of 1000 000F invested for 6years
at a compound interest rate of 8%.

3.4 Calculation of the rate r

= (1 + )
Determination of rate
1) Method 1
= (1 + )
⊄ (1 + )
=
⊄

= (1 + )

Take root on both sides

= (1 + )

=1+ OR +1=

= − 1
3.2.1 Method 2
Using logarithm
Fundamental concepts of logarithm
Log 1 = 0
Log 0.1 = -1
Log A.B = log A + log B
Log = log − log

= n log A
Log √ = log

= 1 log B

Log ( 1 + ) =

Using log to proof the above formula

= (1 + )
Divide both sides by “C”

= (1 + )

Take log on both side

Log = (1 + )

Log = (1 + )

( )
=

= (1 + )

Example 1
A man invested 10,000,000 frs and it amounted to 11,698,600 frs for 4years, what is the rate?
Example 2
3000000 invested for 8years is now 4954967 what is the compounding rate
= (1 + )
 = −1

= 495496

Example 3
A man invested 3000000 at compound interest for 3years and received 3573048frs what is the
compound interest rateType equation here.
Expl: what is the growth rate of a population which doubled in 6years?

Example 2:
Awa invested 4000 000F in his account on the 1/1/2003 and realized a total interest of
180000F by the 31/12/2010. Determine the compound interest rate used by the bank?

Expl 3; Ndongo invested 5000000frs in UBA on the 1/1/2000. What was his investment rate if he received
7000000frs on the 31/12/ 2004

NB: the rate can as well be read from the financial table 1. This is done by calculating the ratio
=(1+i)n
Example1: A man invested an amount of 67565.28frs and after 21 years received 500000frs. Use the
financial table to calculate the compounding rate.

3.5. CALCULATION OF THE DURATION

The duration n =log Fv-logC which can also be written as n= log /log(1+i)
Log(1+r)

Expl 1; Ngenui acquired an amount of 1000000frs after investing 15384frs at a rate of 11%. Calculate the
duration .
Expl 2; How long will it take 100000frs to acquire an interest of 50000frs if it is invested at a rate of 5%
p.a

Expl 3: A capital of 600 000F invested at a compound interest rate of 6% produced a total interest of
251111.46F. use the financial tables to determine the duration.

N.B When the duration and the rate cannot be read directly from the financial table, linear interpolation
is carried out in order to determine the rate or the duration. The procedure is as seen below
X1<X<X2 X=X1+(X2-X1)*Y-Y1
Y2-Y1
Expl: A capital of 1000 000F invested at a compound interest rate of 7.5% produced a total
interest of 629322.8F. Calculate the investment duration using the financial table.

3.6) CALCULATION OF THE PRESENT VALUE (CAPITAL)

The present value is given byPv= Fv(1+r)-n

Expl;MrsKELLY wishes to constitute a capital of 16 000 000frs by the 1/1/2004. what amount
should she deposit in an account earning 6% p.a on the 1/7/1997 annual compounding?

Expl 2)A capital of 10000frs is placed at compound interest. The quarterly rate is 2.5% for a franc.
Calculate the acquired value after 6 years if capitalization is quarterly.

3.The buyer of a car has the choice to choose any of the above modalities
a)to pay 165000frs in a year.
b) To pay 100 000frs in 3 years and in 4 years
what is the best form of payment using a rate of 8%

3.7) calculation of proportional and equivalent rate.

Consider the rates r=that corresponds to the annual and the rate rk=that correspond to the rate of a period k
times smaller than the year. Then
The proportional rate is given by rk= r/k
Example 1: convert a 10% annual rate to the proportional
A)semi annual rate
b)quarterly rate
c)monthly rate
d) daily rate
a) 10/2= 5% b)10/4=2.5% c) 10/12= 0.83% d) 10/360=0.278%

example 2: convert 12% quarterly rate to the proportional

a) Annual rate
b) Semi annual rate
c) Daily rate
Solution
a) 12*4= 48% b) 12*2=24% c) 12/90= 0.1333% (360/4=90)

Equivalent rate:
A capital C is placed at compound interest at an annual rate i for 1frs during n years, annual capitalization
of interest. At the end of the nth year, the acquired value will be C(1+i)n. if we consider the same capital
C place at a semi annual rate i2 still for 1frs, during 2n semesters (during the same length of time as in the
first hypothesis), the interest produced will be capitalized semi annually. The acquired value after one year
(2n semesters) will be C(1+i)2n since the acquired values from the two situations are the same, it implies
That (1+i)n= (1+is)2n
We say that isis the equivalent semi annual rate of the annual rate i.
Generally, the equivalent rate will be given by:
C(1+r)n=C(1+rk)kn
(1+r)=(1+rk)k
Expl;1) calculate the semi annual rate corresponding to an annual rate of 9.5%

Example 2: Convert an annual rate of 15% to the corresponding equivalent

a) Quarterly rate
b) semi annual rate
c) daily rate

Example 3: convert a quarterly rate of 5% to the equivalent

a) annual rate
b) semi annual rate
c) daily rate