Chapter 2

Compound Interest
By Junius W. Yu
Repeat Repeat
In chapter 1, you simply
computed once for
simple interest and
simple discount.
In this chapter, interest
earned per period is
automatically
reinvested sometimes
once, twice or several
times.
By Junius W. Yu
Formula
By Junius W. Yu
Total Number of Conversion Periods
Time/Term
Frequency of Conversion
Frequency
When interest rate is
compounded annually,
interest is computed once
hence one conversion period
is equivalent to one year.
Frequency of conversion (m)
number of times that the
interest is computed in a span
of one year.
By Junius W. Yu
Frequency Conversion Table
Conversion
Period
Time

(t)
Frequency of
Conversion
(m)
Total number
of Conversion
(n = tm)
Annually 1 year 1 year 1 1
Semi- Annually 6 months 5 years 2 10
Quarterly 3 months 3 years 4 12
Monthly 1 month 2 years 12 24
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Interest Rate per period
Nominal Rate (j) is the rate charged
when converted several times per year.
Interest Rate per period (i) divide the
nominal rate by the frequency of
conversion per year.

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Interest Rate per period
By Junius W. Yu
Interest Period Nominal Rate

(j)
Frequency of
Distribution
(m)
Interest rate
per period
(i = j/m)
Annually 1 year 10% 1 10%
Semi- Annually 6 months 12% 2 6%
Quarterly 3 months 14% 4 3.5%
Monthly 1 month 16% 12 1 and 1/3%
Note: Dont Round Off!!!!!
Compound Amount
Rollover !!!
The sum of the original
principal and
compound interest is
compound amount
- the accumulated value
of P at the end of the
term
By Junius W. Yu
Compounding Amount Table
Year Principal Interest Amount
0 1,000,000.00 0.00 1,000,000.00
1 1,000,000.00 1,000.00 1,001,000.00
2 1,001,000.00 1,001.00 1,002,001.00
3 1,002,001.00 1,002.00 1,003,003.00
4 1,003,003.00 1,003.00 1,004,006.00
By Junius W. Yu
The compound amount (F) after 4
years is Php1,004,006.00
Ic = F P = Php1,004,006.00 Php1M
= Php4,006.00
Amount of investment
at the end of n period
Period (n) Principal (P) Interest (I) Amount (F)
0 P 0 P + 0 = P
1 P P (i) P + Pi = P(1 + i)
2 P (1 + i) P (1 + i) (i) P (1 + i)
2

3 P (1 + i)
2
P (1 + i)
2
(i) P (1 + i)
3
4 P (1 + i)
3
P (1 + i)
3
(i) P (1 + i)
4
. . ..
n 1 P (1 + i)
n 2
P (1 + i)
n 2
(i)

P (1 + i)
n 1
n P (1 + i)
n 1
P (1 + i)
n 1
(i) P (1 + i)
n
By Junius W. Yu
n is 2, the exponent of the accumulation factor (1 + i) is 2.
Compound Amount Formula
By Junius W. Yu
Present Value or
Original Principal
number of
conversion
Compound Interest Formula
By Junius W. Yu
Compound Amount
Present Value or
Original Principal
Exercise
1. If Php14,500 is invested for 5 years in a
bank that pays 6% compounded quarterly,
what sum will the investor receive after 5
years? How much interest was earned?

2. Accumulate Php50,000 for 19 months at
24% compounded monthly? How much is
the compounded interest?

By Junius W. Yu
3. Find the compound interest earned at the end
of 2 years and 4 months if Php100,000 is
invested at 12% compounded monthly.
By Junius W. Yu
Given: P = Php14,500; t = 5 years; m = 4; j = 6%
Find: F and Ic
Solution: i = j/m = 0.06/4 = 0.015
n = tm = (5)(4) = 20
F = P (1 + i)
n
Php14,500 (1 + 0.015)
20
Php19,529.40
Ic = Php19,529.40 Php14,500
Php5,029.40
By Junius W. Yu
By Junius W. Yu
Given: P = Php50,000; t = 19 months;
m = 12; j = 24%
Find: F and Ic
Solution: i = j/m = 0.24/12 = 0.02
n = tm = 19/12(12) = 19
F = P (1 + i)
n
Php50,000 (1 + 0.02)
19
Php72,840.56
Ic = Php72,840.56 Php50,000
Php22,840.56
By Junius W. Yu
Given: P = Php100,000; t = 28 months;
m = 12; j = 12%
Find: F and Ic
Solution: i = j/m = 0.12/12 = 0.01
n = tm = 28/12(12) = 28
F = P (1 + i)
n
Php50,000 (1 + 0.01)
28
Php132,129.10
Ic = Php132,129.10 Php100,000
Php32,129.10
Present Value at Compound Interest
By Junius W. Yu
Present Value = F(1 + i)
-n
Exercises
1. What is the present value of Php41,000 due
in 9 years and 3 months if the value is
compounded quarterly at 12%?
2. If money is invested at 7% compounded
semi-annually, find the present value of
Php100,000 which is due in 4 years.
By Junius W. Yu
Given: F = Php41,000; t = 9.25; j = 0.12; m = 4
Find: P
Solution: Solve for i and n
i = j/m = 0.12/4 = 0.03
n = tm = 9.25(4)= 37
Input the values
P = F (1 + i)
-n
= Php41,000(1+0.03)
-37
P = Php13,734.30
Answer: The present value of Php41K that is due
at the end of 9.25 years is Php13,734.30
By Junius W. Yu
Given: F = Php100K; t = 4 years; j = 7%; m = 2
Find: P
Solution: i = j/m = 0.07/2 = 0.035
n = tm = (4)(2) = 8
input the values
P = F (1 + i)
-n

=Php100,000(1+0.035)
-8
Php 75,941.16
Answer: The present value of Php100K that is
due at the end of 4 years is Php58,200.91
By Junius W. Yu
Nominal Rate
is the rate charged
when converted several
times per year
Can be obtained from
the compound amount
formula F = P(1+i)
n

By Junius W. Yu
Nominal Rate Formula
By Junius W. Yu
1
1
n
Exercises
1. A Php85,000 investment earned an interest
of Php4,000 in 3 years. At what nominal rate
compounded annually was the money
invested?
2. If a certain principal triples itself in 5 years,
find the interest rate compounded quarterly
at which it is invested.
By Junius W. Yu
Given: P = Php85,000, Ic = Php4000; m = 1,
Find: j
Solution: n = tm = 1(3) = 3
F=85,000+4000 = Php89,000
=

1 =
89000
85000
1
3
1 1
= 0.0155 or 1.55%
By Junius W. Yu
Given: P, F = 3P, t = 5 years; m = 4; n = 4(5) = 20
Find: j = ?
Solution: =

1
=
3

1
20
1 4
= 0.2259 or 22.59%
By Junius W. Yu
Time?
We count the sands
of time and realize it
is too short to enjoy
and yet too long to
endure?
Legend of the 9
By Junius W. Yu
Finding Time
How long does it take for
an investment to reach
the desired results?

Investors want to know
the return on investment
on any given particular
time.
By Junius W. Yu
John Napier
John Napier inventor of
logarithms.
- Famous mathematician
- Marvelous Merchiston
- Napier bones
- Occult Book of
Revelation
- Apocalypse
- Travel box with spider
By Junius W. Yu
Logarithm
The logarithm of a
number
is the exponent to
which the another
fixed value called
the base
must be raised to
produce the desired
number

By Junius W. Yu
Log
2
8 = 3
Log
10
100 = 2
2
3
= 8
10
2
= 100
Log time formula
By Junius W. Yu
Exercise
1. How long will it take Php65,000 to
accumulate to Php200,000 if invested at 5%
compounded quarterly?
2. How long will it take Php25,000 to become
Php55,000 if it is invested at 11% converted
monthly?
3. Find how long will it take for money to
double itself if invested at 9% compounded
annually, semi-annually, quarterly, monthly?
By Junius W. Yu
Given: P = Php65,000; F = Php200,000; j = 5%
Find: t
Solution: m = 4, i = 0.05/4 = 0.0125
=
log
200000
65000
4 log(1:.0125)

= 22.6188 or 22.62 years
By Junius W. Yu
Given: P = Php25,000; F = Php55,000; j=11%
Find: t
Solution: i = j/m = 0.11/12 = 0.009167
=
log
55,000
25,000
12log(1 +.009167)

= 7.20 years
By Junius W. Yu
Given: P, F= 2P, j = 9%, m = 1, 2, 4, 12
Find: t
Solution: log (2P/P) = log 2 = 0.30103

By Junius W. Yu
Annualy Semi
Annually
Quarterly Monthly
Interest
rate per
period
0.09 0.045 0.0225 0.0075
Log (1+i) 0.037427 0.01912 0.00966 0.00325
m log (1+i)
0.037426 0.038233 0.038653 0.038941
/log 2
8.043232 7.873651 7.787957 7.730481
Comparison of Nominal
and Effective Rates
Nominal Rate the rate
which may be converted
several times a year.
Effective Rate the rate
which when compounded
annually is equivalent to a
nominal rate j,
compounded m times a
year.
By Junius W. Yu
Effective Rate (w) Formula
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Compound Amount Formula (w)
By Junius W. Yu
If the present value or principal is invested for
one year at an effective rate
Compound Amount Formula (n)
By Junius W. Yu
Nominal Rate equivalent to w
By Junius W. Yu
Level I Exercise (+2,+1)
1. What nominal rate compounded monthly is
equivalent to 11% effective?
2. Find the effective rate equivalent to 7%
compounded quarterly. Apply the effective
and nominal rates in order to determine the
compound amount of Php10,000 for one
year.
By Junius W. Yu
Problem 1
Given: w = 11%
Find: j (m = 12)
Solution: = 1 +
1

1
= 12 1 +0.11
1
12
1
= 0.1048 or 10.48%
By Junius W. Yu
Problem 2
Given: j = 0.07; m = 4
Find: w
Solution: = 1 +

1
= 1 +
.07
4
4
1
w = 0.071859 or 7.1859%

By Junius W. Yu
Given: j = 0.07; m = 4; P = Php10,000; t = 1 year
Find: Fe and Fn
Solution: Fe = P(1 + w) = 10,000(1+0.071859)
=Php10,718.59
Fn = P(1+j/m)
m
= 10,000(1 + 0.07/4)4
= Php10,718.59


By Junius W. Yu
Comparison
a. Comparison of Two
Nominal Rates
b. Comparison of
Nominal Rate and
Simple Interest Rate
c. Comparison of
Nominal and Discount
Rate
By Junius W. Yu
Comparison of Two Nominal Rates
Two rates are equivalent if
they produce the same
compound amount for the
same span of time.

Equate F1 = F2
Then solve for j1 and j2
To compare two nominal
rates in terms of profit,
compare their effective
rates. Higher rates, higher
profit.
By Junius W. Yu
Nominal Rate equivalent to w
By Junius W. Yu
Nominal Rate equivalent to w
By Junius W. Yu
Exercises
1. What nominal rate compounded monthly is
equivalent to 15% compounded quarterly?
2. Mr. Wonderful was offered by Bank O, 6%
compounded quarterly for his investment.
Bank Z offers 6.5% compounded semi-
annually for the same amount of investment.
If you are Mr. Wonderful, what would you
do?
By Junius W. Yu
Given: j2 = 15% (m2 = 4), m1 = 12
Find: j1 (m1 = 12)
Solution:
1
=
1
1 +

2

1
1

1
= 12 1 +
0.15
4
4
12
1
= 0.148163 or 14.82%
By Junius W. Yu
Given: Bank O: 6% (m = 4), Bank Z: 6.5% (m = 2)
Find: Preferred Bank
Solution: Compare the effective rates
Bank O: w = (1+0.06/4)
4
1 = 0.061634
or 6.16%
Bank Z: w = (1+0.065/2)2 1 = 0.066056
or 6.61%
Bank Z > Bank O, invest with Bank Z

By Junius W. Yu
Nominal VS Simple Interest Rate
Simple Interest Rate can
also be equivalent to a
given nominal rate.
Based on the assumption
that future amount

F simple interest =
F compound interest

P(1+rt) = P(1+i)
n
By Junius W. Yu
Formula r
By Junius W. Yu
Formula j
By Junius W. Yu
Exercises
1. What nominal rate compounded quarterly is
equivalent to 4.5% simple interest rate in a 4-
year transaction?
2. What simple interest rate is equivalent to
7.25% compounded monthly in a 4-year
transaction?
By Junius W. Yu
Given: r = 4.5%; m = 4; t = 4
Find: j
Solution: n = tm = 4(4) = 16
= 1 +
1

1
= 12 1 +0.045(4)
1
16
1
j = 0.04145 or 4.15%
Answer: The nominal rate 4.15% compounded
monthly is equivalent to 4.5% simple interest

By Junius W. Yu
Given: j = 7.25%; m = 12; t = 4
Find: r
Solution: i = j/m = 0.0725/12 n = tm = 4(12) = 48
=
1:

;1

=
1:
0.0725
12
48
;1
4

= 0.083815 or 8.38%
Answer: A simple interest rate of 8.38% is
equivalent to a nominal rate of 7.25% (m = 12)

By Junius W. Yu
Nominal Rate VS Discount Rate
Instead of simple interest
rate, simple discount rate
can be equivalent to a
given nominal rate

F simple discount rate =
F nominal rate
P/(1-dt) = P(1+i)
n
By Junius W. Yu
Formula d
=
(1 +

1
(1 +

By Junius W. Yu
Formula j
=
1
1
1

1
By Junius W. Yu
Exercises
1. What nominal rate j, compounded quarterly
is equivalent to 12.5% discount rate in a 5-
year transaction?
2. Find the simple discount rate that is
equivalent to a nominal rate of 8.6%
compounded semi-annually in an 8-year
transaction.
By Junius W. Yu
Given: d = 12.5%, m = 4, t = 5, n = (5)(4) = 20
Find: j
Solution: =
1
1;
1

1
= 4
1
1 (.125)(5)
1
20
1
= 0.201056 or 20.11%
By Junius W. Yu
Given: j = 0.0860, m = 2, t = 8
Find: d
Solution: =
(1:

;1
(1:

=
(1:
0.0860
2
)
16
;1
8 (1:
0.0860
2
)
16
= 0.061267 or 6.13%
By Junius W. Yu