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Compound Interest

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You are on page 1of 12

Year

Example 1.

Given a principal of Php 10,000, which of the

following options will yield greater interest after

5 years:

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

= 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 + )

P = principal

() = nominal rate of interest (annual rate)

m = frequency of conversion

t = term/ time in years

Example 2.

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.

50,000 due in 4 years if money is

invested at 12% compounded

semi-annually.

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