COMPOUND INTEREST PART 2

BUSIMATH (Module 3)| SEM 1 | 2023

3.1 NOMINAL RATE AND EFFECTIVE RATE

Nominal Rate and Effective Rate

Two annual rates of interest with different conversion 3. What rate compounded quarterly is equivalent to
periods are said to be equivalent if they earn the 14% compounded semi- annually?
same amount for the same time.
Given:
Nominal Rate (r) – the rate when interest is 𝑟1 = 14%, 𝑚1 = 2,
compounded more than once a year. r2 = ? , 𝑚2 = 4
Effective Rate (u) – rate when compounded annually,
produces the same compound amount each year as
the nominal rate compounded m
times a year.

4. What nominal rate converted semi- annually is

equivalent to 9% simple interest in a 5-year
transaction?

Given:
Examples: 𝑟1 =?, 𝑚1 = 2 : Compound Interest
1. Find the effective rate equivalent to 12% n = t x m = 2 X 5 = 10
compounded quarterly. r2 = 9% t = 5 years : Simple Interest

Given: r = 0.12m = 4

Calculator Solution
Enter 0.12
Press +
Enter 4
Press =, +
Enter 1
Press =, 𝑥𝑌
Enter 4
Press =, -
Enter 1
Press =

2. What nominal rate compounded semi – annually

is equivalent to 8% effective rate?
Given: u = 0.08 m = 2
COMPOUND INTEREST PART 2
BUSIMATH (Module 3)| SEM 1 | 2023

3.2 COMPARISON OF TWO RATES

To compare two rates of interest, we must compare

their effective rates.

Review:
Effective Rate (u) – rate when compounded annually,
produces thesame compound amount each year as
the nominal rate compounded m times a year.

Examples:

1. Which is better, to invest money at 6%

compounded monthly or
at 6 ½% compounded semi annually?

Given :
r1 = 6 %, m1 = 12, i1 = r/m = .06/12 = 0.005
r1 = 6 1/2 %, m1 = 2, i1 = r/m = .065/12 = 0.0325

3.3 CONTINUOUS COMPOUNDING

Continuous compounding is where the interest is

converted every instant or where the frequency or
conversion becomes infinite.

2. Which investment would yield a higher interest, Interest may also be converted very frequently:
10 2/3% compounded monthly or at 10 ¾% weekly, daily, or hourly.
compounded bi – monthly?

Given:

Examples
1. P690 was invested for 4 years at 7 ½%
compounded continuously. Find the amount in 4
years.

Given: P = 690 j = 7 1/2 % = 0.075 t = 4 years

3. Banco de Lipa offers 9 5/8% compounded Solution:
quarterly for their savings account while Rural Bank
Lipa offers 9 7/11% compounded semi-annually. If
you were a depositor, in which bank would you
prefer to invest? Justify your answer.
COMPOUND INTEREST PART 2
BUSIMATH (Module 3)| SEM 1 | 2023

2. What is the present value of P150, 000 that is due

at 9 4/5% compounded continuously after 5 years
and 4 months?

Given: F = 150000 j = 9 4/5 % t = 5 4/12
2. Find the amount at the end of 15 years if P120,
000 is invested at an interest rate of 10% converted
quarterly in the first five years, 9% converted semi –
annually in the second five years, and 8% converted
annually in the last five years.

Given: P = P120,000
3. Which is better, to invest P52, 450 at 12 ¾%
𝑟1 = 0.10 𝑚1 = 4 𝑡1 = 5 𝑦𝑒𝑎𝑟𝑠 𝑖1 = 0.025 n1=20
compounded monthly or at 12 2/3% compounded
𝑟2 = 0.09 𝑚2 = 2 𝑡2 = 5 𝑦𝑒𝑎𝑟𝑠 𝑖2 = 0.045 n2= 10
continuously for 8 years and 3 months?
𝑟3 = 0.08 𝑚3 = 1 𝑡3 = 5 years 𝑖3 = 0.08 n3=5

3. Albert invested P20,000 on November 30, 2004 at

10 ¾% compounded semi – annually. If the interest
rate increased to 11% compounded monthly on May
30, 2006, how much will be his accumulated balance
on October 30, 2006?

Given:
P = P20,000
𝑟1 = 0.1075 𝑚1 = 2 𝑡1 = 1.5 𝑦𝑟𝑠 𝑖1 = 0.05375 n1= 3
3.4 VARYFYING INTEREST 𝑟2 = 0.11 𝑚2= 12 𝑡2 = 5/12yr 𝑖2 = 0.009166 n2 = 5

If the interest rate changes during an investment

term, the amount at the previous rate is first
obtained before applying the new rate.

Examples:
1. Find the amount in 15 years if P500 is invested at
18% compounded semi – annually in the first five
years, 15% compounded semi – annually in the next
four years and 18% compounded quarterly in the
last 6 years.

Given :
P = 500
r1 = 18%, r2 = 15%, r3 = 18%
t1 = 5 yrs, t2 = 4 yrs, t3 = 6 yrs
m1 = 2, m2 = 2, m3 = 4
i1 = 0.09, i2 = 0.075, i3 = 0.045,
n1 = 10 periods, n2 = 8 periods, n3 = 14 periods
COMPOUND INTEREST PART 2
BUSIMATH (Module 3)| SEM 1 | 2023

diagram and transfer all values to the comparison

3.5 EQUATION OF VALUES
Objective
To settle a set of obligations/debts by a single
payment or a set of payment
Equations of Value
● Based on the concept the two sets of
obligations (debts) which are equivalent on
one date are equivalent on my other dates.
Comparison Date – Common Date
● The sum of the values of one set of debts on a
comparison date (CD) equals the sum of the
values of another set of debts on the same
date.
● The sum on the comparison date is obtained
by either
date (CD).
5. Choose the comparison date ( usually a payment
date). The CD must be chosen such that the
computations is simplified.
6. Bring all values to the comparison date either
accumulating or discounting. Write the equations of
values using the concept of:
All payments = All debts
7. Then solve for the unknown.
Examples:
1. If money is worth 5% compounded quarterly,
what single payment at the end of 4 years will
equitably replace the following set of obligations.
a. P 3000 at the end of 2 years.
b. P 4000 due at the end of 3 years with 7 ½%
simple interest.
c. P 1500 due at the end of 6 years with interest at
4% converted semi-annually.
d. P 2800 due at the end of 8 years with interest at
3% compounded quarterly.

● ACCUMULATING or DISCOUNTING,
depending on when the obligation and the
comparison date will fall.

● A time diagram aids in visualizing the

problem.

● This method settles a set of obligations/debts

by a single payment or a set of payments

In an equation of value, the sum of the values of one

set of debts on a comparison date (CD) equals the Place all the obligations and payment along the time
sum of the values of another set of debts on the diagram and transfer all values to the comparison
same date. date (CD)

The sum on the comparison date is obtained by either

ACCUMULATING or DISCOUNTING, depending on
when the obligation and the comparison date will fall.
This method settles a set of obligations/debts by a
single payment or a set of payments. A time diagram
aids in visualizing the problem.

Payments = Obligation/Debts Solution:

Form the equation by separating the payment
Steps: from the obligations and solve the resulting
1. Compute the interest rate per period of the given equation.
settlement rate and frequency of conversion.
2. Compute the maturity value of the obligations.
3. Represent the unknown by x.
4. Make a time diagram.
Place all the obligations and payment along the time
COMPOUND INTEREST PART 2
BUSIMATH (Module 3)| SEM 1 | 2023

Since, “Payment” = “Debts”

2. Mrs. Sandoval borrowed two amounts

a) P 20,000 due without interest at the end of 8
years, and
b) P 30,000 due at the end of 4 years with interest
from today at 8%
compounded semi-annually.

Mrs. Sandoval will settle her obligations by two equal

payments at the end of 2nd and 7 years. If money is
worth 12 % compounded quarterly, find the new
payments

Solution:
Compute for the maturity value of the debts: MV1 =
20,000, MV2 = 30,000(1 + 0.08/2)8 = 41,057.07 Place all
obligations and payments along the time diagram
using a comparison date (year 4)