Continuous Compounding and Discrete Payments In diserete compounding, the interest. is compounded at the end of each finite — length period, such as a month, a quarter or [Link]. In continuous compounding, it is assumed that cash payments occur once per year, but the compounding is continuous throughout the year. Figure 2-3. Continuous Compounding (Lender’s Viewpoint) r = nominal rate of interest per year = = rate of interest per period m =number of interest periods per year mn number of interest periods in n years F=P(1+5)™ 2-9) 18Let = =k, then m = rk, as m increases so must k Cay Or) 1G ek The limit of (1+ ) * as k approaches infinite is e [Gay Ee Thus, F 2 P Pe™ (2-10) Fem (2-11) (2-7) Compare the accumulated amounts after’ years of P1,000 : invested at the rate of 10% per year compounded (a) annually, (b) semiannually, (c) quarterly, (d) monthly, (e) daily, and (f) continu- - -ously. Solution Using the formula, F = P(1 +i? _ (a) F = P1,000(1 + 0.10) = P1,610.51 (b) F = 1.000(1 + 220)- = P1,628.89 , () F = P1,000 Q +210, = 1,638.62 “@F = Pato (ste 8 P1,645,31 () F = 1,000 (1 + 940 9.10 )™ _ Piiess.61 () F = Pe™ = P1,000(e)""™ = P1,648.72 Discount Discount on a negotiable paper is the difference between the present worth (the amount received for the paper in cash) and the ° worth of the paper at some time in the future (the face value of the paper or principal). Discount is interest paid in advance,Discount = Future Worth — Present Worth The rate of discount is the discount on one unit of principal for one unit of time. Gey Figure 2-4 Rate of Discount - d = 1-(1+i7 (2-12) iv d (2:18) TT where: ‘d = rate of discount for the period involved i = rate of interest for the same period (2-8). Aman borrowed P5,000 from a bank and agreed to pay the loan at the end of 9 months. The bank discounted the loan and gave him P4,000 in cash. (a) What was the rate of discount? (b) What was the rate of interest? (c) What was the rate of interest for one year? Solution P4000. ; PO.80 P5,000discount _ P1,000 _ (a)d = ‘prindpal = “P5000 = 0.20 or 20% Another solution, using equation (2-12), “d= 1-0,80 = 0.20 or 20% : ep 20:20 (b) i T-d = 1-020 7 0.25 or 25% Another solution, fy interest. = -P1,000 ae present worth ~ P4,000 = 0.25 or 25% ; I () i = == ——P1.009 = 0.3333 or 33.33% Pn a (P4,000) (- iz) Inflation Inflation is the increase in the prices for goods and services from one year to another, thus decreasing the purchasing power of money. FC=PC(I1+f)" 2-14), where PC = present cost of a Commodity FC future cost. of the same commodity f annual inflation rate n. = number of years (2-9) An item presently costs P1000. If inflation is at the rate of 8% per year. what. will be the cost. of the item in two years? Solution FC = PC (1 +f)" = P1000 (1 + 0.08)? = P1166.40In an inflationary economy, the buying power of money decreases as costs intrease. Thus, where F is the future worth, measured in today’s pesos, of a present amount P. (2-10) An economy is experiencing inflation at an annual rate of 8%. If this continues, what will P1000 be worth two years from now, in terms of today’s pesos? Solution ee P1000_ _ Fee 7 Ts 00g! 7 P8878 If interest is being compounded at the same time that inflation is occurring, the future worth will be ES TA =P P¢ iP + G16 en 11) A man invested P10,000 at an interest rate of 10% compounded annually. What will be the final amount of his investment,’ in terms of today’s pesos, after five years, if inflation remains the same at the rate of 8% per year? Solution ‘FeP (ths P10,000 (1+ 0-10) © pio,960.86