COMPOUND INTEREST
In compound interest, the interest earned by
the principal is not paid at the end of each
interest period, but is considered as added to
the principal, and therefore will also earn
interest for the succeeding periods. The
interest earned by the principal when invested
at compound interest is much more than that
earned by the same principal when invested at
simple interest for the same number of
periods.
Using the same nomenclature as that for
simple interest, the total amount due after “n”
periods for compound interest is given by the
formula:
F = P ( 1 + i )n
The factor ( 1 + i )n is called the “Single
Payment Compound Amount Factor.
Nominal Rate of Interest
For compound interest, the rate of interest
usually quoted is nominal rate of interest
which specifies the rate of interest and the
number of interest periods per year. Thus, a
nominal rate of interest of 8% compounded
quarterly means that there are 4 interest
periods each year, the rate per period being
8% / 4 = 2%.
Effective Rate of Interest
The effective rate of interest is the actual rate
of interest on the principal for one year. It is
equal to the nominal rate if the interest is
compounded annually, bur greater than the
nominal rate if the number of interest periods
per year exceeds one, such as for interest
compounded semi-annually, quarterly or
monthly. To make this clearly, imagine ₱1.00
to be invested at the nominal rate of 8%
compounded quarterly. This amount will
become after one year,
0.08 (1)(4)
=₱1.00 ( 1 + )
4
=₱1.00 (1.0824)
=₱1. 0824
Thus, the actual interest earned is ₱0. 0824.
This corresponds to an effective rate of 8.24%,
which is greater than the nominal rate of 8%
compounded quarterly. In general, if F1 is the
amount ₱1.00 becomes after 1 year, “n” the
number of periods in one year, and “i” the rate
of interest period, then the effective rate in
decimal form is:
Effective rate of interest = F1 – 1
= ( 1 + i )n – 1
Examples: i= 0.0254 or 2.54%

1. If the sum of ₱12,000 id deposited in an F = P ( 1 + i )n at 10 years

account earning interest at the rate of 9%
= ₱1,000 ( 1 + 0.0254 )(10)(4)
compounded quarterly, what will it
become at the end of 8 years? = ₱1,000 ( 1.0254 )40

0.09 (8)(4) = ₱ 2727.30

F = ₱12,000 ( 1 + )
4

= 12,000 (1.0225)32

= ₱24,457.24

2. At a certain amount interest rate

compounded quarterly, ₱1,000 will
amount to ₱4,500 in 15 years. What is the
amount at the end of 10 years?

F = P ( 1 + i )n at 15 years

₱4,500 = ₱1,000 ( 1 + i )(15)(4)

₱4,500 = ₱1,000 ( 1 + i )(60)

₱ 4,500
= ( 1 + i )(60)
₱ 1,000

4.5 = ( 1 + i )60

60 60
√ 4.5 = √ (1+i)60
60
√ 4.5 = 1 + i
60
√ 4.5 − 1 = i
1
NOTE: 60√ 4.5 = ( 4.5) 60

1
i= ( 4.5) 60 – 1