Lesson 2: Compound Interest

• Compound Interest – interest calculated on the total of the principal and previously calculated interests
Example:
If ₱1 000 earns 10% interest compounded annually, the following table shows the compound interests for 5 years.

• Compounding Period – the time interval it takes for money to earn interest in a year
Example:

• Nominal Rate – the annual interest rate that does not take into account the compounding period
Example:
If a loan earns an interest of 12% and is compounded quarterly per annum, then 12% is the nominal rate.

• Periodic Rate – the interest rate per compounding period; equal to the nominal rate divided by the number of
compounding periods in a year
Example:
If a loan earns an interest of 12% and is compounded quarterly per annum, then 12%÷4=3% is the periodic rate.

• Compound Amount – the accumulated value of the principal and all interests from prior periods; usually calculated
first before determining the net interest on the original loan or investment; given by the formula

( )
mt
r
C=P 1+
m

where 𝑃 is the principal amount, 𝑟 is the nominal rate, 𝑚 is the frequency of the compounding period, and 𝑡 is the
time in years.
Example:
What is the compound amount of a ₱10 000 loan with an interest rate of 10% compounded semiannually in 1
year?

( ) ( )
mt ( 2 )( 1)
r 0.10
C=P 1+ =10 000 1+ =11 025
m 2
• Formula for Compound Interest – is calculated as the difference between the compound amount and the original or
principal amount. It is calculated as:

I =C−P