CONTINUOUS

COMPOUNDING
Engr. Antonio Carmelito Lizada
Continuous Compounding
As has been seen, compounding can be done
yearly, quarterly, monthly, or daily. The periods can be
made even smaller—as small as desired; the main
disadvantage in having very small periods is having to do
more calculations. If the period is made infinitesimally
small, we say that interest is compounded continuously.
 There are situations in which very frequent
compounding makes sense. For instance, an improvement
in materials handling may reduce downtime on machinery.
There will be benefits in the form of increased output that
may be used immediately. If there are several additional
runs a day, there will be benefits several times a day.
Another example is trading on the stock market.
Personal and corporate investments are often in the form of
mutual funds. Mutual funds represent a changing set of
stocks and bonds in which transactions occur very
frequently, often many times a day.
• Two variables we have introduced are:
• r = Nominal interest rate per interest period
• m =Number of compounding sub periods per time period
• Since the interest period is normally one year, the
definitions become:
• r = Nominal interest rate per year
• m =Number of compounding sub periods per year

• r/m = Interest rate per interest period

• mt = Number of compounding sub periods in n years
• The single payment compound amount formula

𝑟 𝑚𝑡
• may be rewritten as 𝐹 = 𝑃 1 +
𝑚
• If we increase m, the number of compounding subperiods
per year, without limit ,m becomes very large and
approaches infinity, and r/m becomes very small and
approaches zero.
• This is the condition of continuous compounding, that
is, where the duration of the interest period decreases
from some finite duration ∆t to an infinitely small duration
dt, and the number of interest periods per year becomes
infinite. In this situation of continuous compounding:
𝑟 𝑚𝑡
𝐹 = 𝑃 1+
𝑚
• An important limit in calculus is:

1/𝑥
lim 1 + 𝑥 = 2.71828 = 𝑒
𝑥→0
• If we set x = r / m, then mt may be written as (1/x)(rn). As
m becomes infinite, x becomes 0.

• the quantity inside the brackets equals ℮.

• We see that for continuous compounding,