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Assignment 2: LASA 1: Compound Interest

A common component of investing money is to take advantage of a financial institution’s willingness to


pay compound interest. Compound interest is basically interest paid on a deposit that continually
accumulates interest. In general, the formula for compound interest can be represented by the following
exponential function:

P(t) = P0ₑkt P(t) = P0ert

In this formula, P(t) represents the total money in the account after t years given the interest rate k which
is compounded continuously. In this assignment, you will use this formula to explore the affect that
compound interest can have over a period of time and at different interest rates.
Directions:
1. Select an amount of money that you would like to invest (for example $1000.00). This will be
your P0 value.
2. Let your interest rate be k = 0.5%.
3. Write out the exponential function using the P0 and k values you have.
4. Determine the value of your investment after 1, 5, and 1 mm, 0 years.
5. Now, find the doubling time T for your investment. In other words, at what time would your
initial deposit double in value?
6. Repeat steps 3 through 5 for k = 1%.
7. Repeat steps 3 through 5 for k = 1.5%.
In a Microsoft Word document, prepare a report that includes answers to the following:.
1. Report the results of the calculations you performed above.
2. What effect did changing the interest rate have on the rate at which your investment grew?
3. What effect did changing the interest rate have on the doubling time (time until your initial
deposit doubled in size)?
4. Assume that this money is being invested in a savings account. Are the interest rates we
selected realistic for such an account today?
5. Consider the formula we used to determine the future value of our deposit. Is this formula a
realistic approximation of what we could expect from an investment or are there other issues or
factors that must be considered?
6. Besides savings accounts, what other kinds of investment accounts or programs are typically
offered at your bank? Do these accounts use compound interest? What are the typical interest
rates for these accounts?
7. Use your textbook or another reference to research how to calculate simple interest. Given
what you know about compound and simple interest, which would you prefer that your
investment programs were based upon? Why?

1. Report the results of the calculations you performed above.


P(t) = P0ert
$1000.00 Year 1 Year 5 Year 10
0.5% 164.87212707 1218.24939607 14841.3159103
1% 271.828182846 14841.3159103 2202646.57948
1.5% 448.168907034 180804.241446 326901737.247

P0 (doubled)
$2000.00 Year 1 Year 2 Year 3
0.5% 1213.06131943 164.169997248 13.14758939982
1% 735.758882343 13.4758939982 0.090799859525
1.5% 446.260320297 1.1061687403 0.000611804641004

Report the results of the calculations you performed above.

2. What effect did changing the interest rate have on the rate at which your investment grew? As the
interest rate increased the value increased.
3. What effect did changing the interest rate have on the doubling time (time until your initial deposit
doubled in size)? As interest rate increased value decreased.
4. Assume that this money is being invested in a savings account. Are the interest rates we selected
realistic for such an account today? No the interest rates are too high, Today the most common
interest rate on savings accounts is 0.01.
5. Consider the formula we used to determine the future value of our deposit. Is this formula a
realistic approximation of what we could expect from an investment or are there other issues or
factors that must be considered? Yes
6. Besides savings accounts, what other kinds of investment accounts or programs are typically
offered at your bank? Do these accounts use compound interest? What are the typical interest
rates for these accounts? The different type of investment accounts and programs offered by
banks are Interest-Bearing Checking Accounts with the average of 0.05 % interest, Money Market
Deposit Accounts with the average interest rate around 0.26% (MMDAs), Certificates of Deposit
(CDs) averaged 0.51% interest rate, and Bonds with an average interest rate of 0.10%. Theses
account also use compound interest.
7. Use your textbook or another reference to research how to calculate simple interest. Given what
you know about compound and simple interest, which would you prefer that your investment
programs were based upon? Why? Simple interest is calculated on the principal, or original,
amount of a loan. Compound interest is calculated on the principal amount and also on the
accumulated interest of previous periods, and can thus be regarded as “interest on interest.” I
prefer compound interest for my investments, it is much for lucrative.
http://www.investopedia.com/articles/investing/020614/learn-simple-and-compound-interest.asp