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Topic 4 Compound Interest

Mathwo

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17 views

Topic 4 Compound Interest

Mathwo

Uploaded by

dantekailey9
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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Topic 4:

Compound Interest
The compound interest is interest that results from adding the interest to the
principal periodically. When interest is added to the principal and the sum
becomes the new principal for which the interest is computed for a certain
periods of time, the resulting amount is the final amount or compound
amount. The interest computed from the new principal is called the compound
interest. Compound interest is computed between successive time. You call
the time between this successive computations as compounding or
conversion period. The number of conversion periods for the whole year is
usually denoted by m, while the number of conversion periods for the whole
term of the loan is denoted by n. Conversion periods are usually expressed by
any convenient length of time, and this is usually the exact division of the year,
like monthly, quarterly, semi-annually and annually. For this case, when the term
is converted monthly, then m=12, when converted quarterly, m=4, when
converted semi-annually, m=2, and when it is converted annually, m=1. For the
total conversion periods n for the whole term of the loan, this is obtained by
multiplying the conversion period and the term of the loan (t x m).
For example, the total conversion period for a loan in 10 years converted:
Monthly is 10 x 12, n = 120
Semi-annually is 10 x 2, n = 20
Quarterly is 10 x 4, n = 40 and
Annually is 10 x 1, n = 10

On the other hand, unlike the simple interest, the interest rate in
compound interest is usually expressed as an annual or yearly rate.
Learning objectives:
Upon the completion of this topic, you are expected to:
▪ Compute for the compound interest;
▪ Explain the advantages/disadvantages of compound interest,
both to the lender and the borrower; and
▪ Appreciate the importance of this type of interest in real life
situation.
As earlier discussed, compound interest is computed from the new principal
(principal plus the interest).

To find for the compound interest, it is very important to note the following:
A) Conversion periods (m) is given in exact division of the year such as:
m = 1 (annually)
m = 4 (quarterly)
m = 2 (semi-annually)
m =12 (monthly)

B) Total conversion periods (n) is computed using the formula:


n = time (t) x conversion periods (m)
a) Periodic rate (i) per conversion period is computed using the formula:
To compute the compound interest, the following formula is used:
Example
Find the compound amount and interest on P25,500 invested at 5% for 5
years, compounded quarterly.

Solution:
Given: P = P25,500
r = 5% (.05)
t = 5 years
m = 4 (quarterly)
a) F = P (1+i)n, substituting the values, we have
= 25,500 (1 + 0.0125)20
= 25,500 ( 1.28) = 32,640
b) I= F - P
= P32,640 - P25, 500
= P7,140

The amount of P25,500 invested for 5 years at 5% compounded


quarterly has compounded into P32,640. It earned an interest of
P7,140.
Now, let us compare compound interest with simple interest. Using the
same problem above, the interest is:

I =Prt
= P25,500 (0.05) (5)
= P6,375
--End--
Application
▪ Find the compound amount and interest on P23,560 for 2 years and 3
months at 6%, m=2.

▪ What final amount and interest will be due after 4 years on a loan of
P32,400 at 5 1/2% compounded annually?

▪ Find the compound amount and interest on P17,450 for 4 years and 2
months at 4.5% compounded semi--annually?

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