You are on page 1of 12

Compounding More than Once a

Year
Example 1.
Given a principal of Php 10,000, which of the
following options will yield greater interest after
5 years:

A. Earn an annual interest rate of 2% at the end


of the year.
B. Earn an annual interest rate of 2% in
two portions 1% after 6 months, and 1
% after another 6 months?
Option A: Interest is compounded annually
Time Principal = Php 10,000
in Annual Int. rate = 2%, compounded
years annually
(t)
Amount at the end of the year
1 10,000 x 1.02 = 10,200
2 10,200 x 1.02 = 10,404
3 10,404 x 1.02 = 10,612.08
4 10,612.08 x 1.02 = 10,824.32
5 10,824.32 x 1.02 = 11, 040.81
Option B: Interest is compounded semi-annually, or every 6
months.
Under this option, the interest rate every six months is 1%
(2% divided by 2)
The investment scheme in option B introduces
new concepts because interest is compounded
twice a year, the conversion period is 6
months, and the frequency of conversion is 2.
As the investment runs for 5 years, the total
number of conversion periods is 10. The
nominal rate is 2 % and the rate of interest for
each conversion period is 1%.
Definition of Terms:
Frequency of Conversion (m) - Number of conversion periods in 1 year
Conversion or interest period - Time between successive conversions
of interest
Total number of conversion periods (n)
n= (m)(t) = (frequency of conversion) x (time in years)
Nominal rate ( ()
) - Annual rate of interest
Rate (j) of interest for each conversion period
()

= =

Examples of nominal rates and the corresponding frequencies of
conversion and interest rate for each period
() =Nominal Rate m= Frequency J=Interest Rate per One conversion period
(Annual Interest Rate) of Conversions conversion period

2% compounded annually; 1 0.02 1 year


= 0.02 = 2%
(1) = 0.02 1
2% compounded semi- 2 0.02 6 months
= 0.01 = 1%
annually; 2
(2) = 0.02
2% compounded quarterly; 4 0.02 3 months
= 0.005 = 0.5%
4 = 0.02 4
2% compounded monthly; 12 0.02 1 month
= 0.0016 = 0.16%
12 = 0.02 12
2% compounded daily; 365 0.02 1 day
365 =0.02 365
..\Desktop\Table for powerpoint.docx
Maturity Value, Compounding m times a year




= (1 +

) or = (1 + )

Where: F = maturity (future) value


P = principal
() = nominal rate of interest (annual rate)
m = frequency of conversion
t = term/ time in years
Example 2.

Find the maturity value and interest


if Php 10,000 is deposited in a bank
at 2% compounded quarterly for 5
years.
Present Value P at Compound Interest


=

(1 + )

Where: F = maturity (future) value
P = principal
() = nominal rate of interest (annual rate)
m= frequency of conversion
t= term/ time in years
Example 3.

Find the present value of Php


50,000 due in 4 years if money is
invested at 12% compounded
semi-annually.