COMPOUND INTEREST

Compound Interest
• Compound interest (Ic) is usually used by
banks in calculating interest for long-term
investments and loans such as savings
account and time deposits. In this type of
interest, the principal increases by adding the
interest earned in each interval over a period
of time.
Compound Interest
• Compound interest is an interest
resulting from the periodic addition of
simple interest to the principal amount or
simply the difference between the
compound amount and the original
principal.
Definition of Terms
• Compound amount (F) – also called maturity value, it is an
accumulated amount obtained by adding the principal and the
compound interest.
• Conversion period or frequency of conversion (m) – the
number of times in a year the interest will be compounded.
The following are the common conversion periods in a year:
annually : m=1
semi-annually : m=2
quarterly : m=4
monthly : m = 12
Definition of Terms
• Total number of conversion periods (n) – the total
number of times interest is calculated for the entire
term of the investment or loan.
n = mt = (frequency of conversion) x (time in years)
• Annual interest rate or nominal rate (r) or (𝒊𝒎 ) –
the stated rate of interest per year.
Definition of Terms
• Periodic rate (i) or (j) – the interest rate per
conversion period.
• Rate (j) of interest for each conversion period
𝒊𝒎 𝒂𝒏𝒏𝒖𝒂𝒍 𝒓𝒂𝒕𝒆 𝒐𝒇 𝒊𝒏𝒕𝒆𝒓𝒆𝒔𝒕
𝒋= =
𝒎 𝒇𝒓𝒆𝒒𝒖𝒆𝒏𝒄𝒚 𝒐𝒇 𝒄𝒐𝒏𝒗𝒆𝒓𝒔𝒊𝒐𝒏
Definition of Terms

Present value of F (P) – this is the principal P,

that will accumulate to F if there is an interest
at periodic rate i for n conversion periods.
Formula for Maturity(Future)
Value of Compound Interest

𝒕
𝑭 = 𝑷(𝟏 + 𝒓)
where:
F = future value
P = principal amount
r = compound interest rate
t = time or time in years
Formula for the Maturity(Future)
Value for interest compounding m
times a year.

𝑭 = 𝑷(𝟏 + 𝒋)𝒏 or
where:
F = maturity value
P = present value
𝒊𝒎 𝒓
j= =
𝒎 𝒎
n = mt
Formula for
Compound Interest
𝑰𝒄 = 𝑭 − 𝑷
𝑰𝒄 = 𝑷[(𝟏 + 𝒋)𝒏 − 𝟏]
where:
𝑰𝒄 = compound interest
P = principal or present value
F = maturity (future) value
t = time or time in years
Formula for the Present Value
or Principal of the Maturity
Value F due in t years

𝑭
𝑷=
(𝟏 + 𝒓)𝒕

or

𝑷 = 𝑭(𝟏 + 𝒓)−𝒕
Formula for the Present Value
given the Maturity Value F

𝑭
𝑷= or 𝑷 = 𝑭(𝟏 + 𝒋)−𝒏
(𝟏 + 𝒋)𝒏

or
Formula for finding the Rate
Formula for finding the Time
Study the
table
below.
4 – Step Rule of George Polya
Drill:

1. What is the frequency of conversion if the annual rate is compounded

monthly? Semi-annually? Quarterly? Daily?
Drill:

2. If the interest rate is 12% compounded quarterly, what is the interest rate per
conversion period?
Drill:
3. Given that F = ₱50,000 and P = ₱38,000 how much is the compound
interest?
Drill:

4. If the maturity value is ₱80,000 and the compound interest

is ₱16,500, how much is the present value?
Example #1:
How much must Diane set aside and invest in a fund earning 2.1%
compounded quarterly if she wants to accumulate P50,000.00 in 5 years.
Example #2:

• Given the following values: P = P120,000; i2 = 5% ; t = 4

years, m = 2. Find the maturity value and compound interest.
Assignment #1: (35 points)
Copy and complete the table.
SIMPLE INTEREST.

1 2
3 4
5 6

COMPOUND INTEREST.

7 8 9 10
11 12 13 14
Assignment # 1: Cont…
Analyze and solve the following problems below. Show your complete solution.
1. How much should be deposited in the bank paying 1.25% compounded semi-
annually to accumulate an amount of P125,000 for 5 years? (5points)
2. James invested P150,000.00 at 2.5% interest compounded semi- annually. Find the
maturity value if he invest for (a) 4 years (b) 8 years? (c) How much is the
additional interest earned due to the longer time? (8 points)
3. Jenny is planning to deposit P20,000. BPI Bank is offering 7.5% compounded
semi-annually for 5 years while Metrobank is offering 7% compounded monthly
for 5 years. Which bank should she deposit her money? (8 points)