COMPOUND

INTEREST
PREPARED BY: MS. VANESSA T. GARGANERA, LPT
Does anyone have any interest in interests?

 Very few banks today pay interest based on the simple

interest formula. Instead, they pay interest by using a
principle called compounding.

 The difference between simple and compound interest is

that simple interest grows slowly, compounding speeds up
the process.
How does it work?

 Simple interest is interest on the principal amount.

 Compound interest is when your principal and any earned

interest both earn interest.
INFORMATIONS

 Compound interest is calculated on the original principal

and the interest earned by an account.
 Itis usually used by banks in calculating interest for long-
term investments and loans such as savings account and
time deposits.
 Interestmay be compounded periodically such as annually,
semi-annually, quarterly, monthly or daily over the life of
the investment or loan.
COMPOUND AMOUNT AND INTEREST

 The compound amount or future value is the final of the

investment or loan at the end of the term or last period.

 Thecompound interest is the difference between the

compound amount and the original principal.
Example: If ₱10,000 is invested for 3 years at 8% compounded annually, the
compound amount and interest shall be calculated, as follows:

Given: P = ₱ 10,000 R = 8%
T= 3 years

Solution: Using I = P R T and M = P+ I, we have:

Interest New Principal (M)

First Year = ₱800.00 = ₱10,800.00
Second Year = ₱864.00 = ₱11,664.00
Third Year = ₱933.12 = ₱12,597.12
Total = ₱2,597.12
 Compounding Frequencies and Periods
Number of Compounding Periods in 1
Interest Compounded
Year
1. Annually or once a year 1
2. Semi-annually or every 6 months 2
3. Quarterly or every 3 months 4
4. Bimonthly or every 2 months 6
5. Monthly or once a month 12
6. Daily or once a day 365/366 (leap year)
Terms
1. Conversion Period or Interest Period – this is the time between
two successive conversion of interest.

2. Frequency of Conversion (m) – this is the number of conversion

periods of the investment or loan per year. Examples: monthly
(m=12) and quarterly (m=4).

3. Nominal Rate (j) – this is the stated rate of interest per year.
Example: means 8% interest per year.
Terms
4. Rate per Conversion Period (i) – this is the rate of interest for
each conversion.

Examples:
For 8% compounded quarterly,

For 9% compounded monthly,

Terms
5. Number of Conversion Periods– this is the total number of
times interest is calculated for entire term of the investment or
loan. It is obtained by multiplying the time in years by the
frequency of conversion per year.

or
Example:
If t=2 years compounded quarterly, then

or
Compound Interest Formulas:

or

and

Where
P = original principal
F = compounded amount or maturity value or accumulated value of P
at the end of n periods.
j = nominal rate or annual rate of interest
m = frequency of conversion per year
i = interest rate per conversion period
t = term of investment or loan in years
n = total number of conversion periods in the investment term
 Computing the Maturity Value
1. Determine the maturity value of ₱3,000 invested at 9.5% compounded
semiannually for years.
Solution:
Given: P = ₱3,000 j = 9.5%
t = years = 3.5 years
m=2 n = tm = 3.5(2) = 7
i = = = 0.0475

₱4,151.45
The maturity value will amount to ₱4,151.45 after years.
 Computing the Maturity Value

2. Find the compound amount if ₱48,000 is deposited in a bank paying

8% compounded quarterly for 6 years.
3. CJ borrowed ₱50,000 from Edlin. He promised to pay the interest
and the principal after 4 years. How much would Edlin receive from
CJ if he charged interest at 9% compounded monthly?
4. Find the maturity value if ₱38,850 is invested at compounded
annually for 5 years.
Present Value on Compound Interest
The present value starts with the future and its worth is calculated in the present. Therefore,
the present value of an amount due in n interest periods is the value of P which is invested at a given
rate.
The present value can be derived from the compound amount formula, as follows:

Hence, to find the present value of a compound amount, we shall use the following formula:

The factor is called the discounting factor.

 Computing the Present Value
1. What amount must be invested now in savings account earnings 9% compounded
quarterly to accumulate a total of ₱21,000 after years?
Solution:
Given: F = ₱21,000 j = 9% = 0.09
t = years = 4.75 years
m=4 n = tm = 4.75(4) = 19
i = = = 0.0225

P₱
A total of ₱ must be invested now to accumulate ₱21,000 after years.
 Computing the Present Value

2. Mrs. Sirug wants to provide a ₱200,000 graduation gift for her

daughter Sofia. She is now 16 years old, and she would like the fund
to be available by the time she is 20. She decides on an investment
that pays 10% compounded quarterly. How large must the deposit
be?
3. Find the present value of ₱12,850 due in 3 years if the interest rate is
8% compounded quarterly.
4. How much must be invested today in a savings fund to accumulate
₱80,000 after 5 years if money earns 7.5% compounded monthly?