AUTONOMOUS UNIVERSITY OF THE CARIBBEAN

FCAEC
FINANCIAL MATHEMATICS
GROUP P2
COMPOUND INTEREST
SOLVED EXERCISES

1. A deposit of $100,000 is made in a corporation that recognizes a 32% annual interest with quarterly compounding, what will be
the accumulated value after 2 years?

SOLUTION

(When a problem includes the expression 'capitalization' we know that the solution must be developed accordingly
with the concept of compound interest)

Problem data
There is an initial deposit (an expense), P = $100,000. From there, we also deduce that the analysis is done by the
capital depositor, not the financial corporation. That also indicates the direction of the arrows in the
economic diagram.
They give us a nominal rate (we know it is, because as seen in the class video, it is expressed
as an annual rate that is compounded n times during one year. The rate is: r = 0.32 annually, compounding
quarterly.
The investment period (deposit) is n = 2 years. As for capitalization, that is, the accrual of
interests are quarterly, so we need to express this period in quarters. Therefore: n = 2 years ≈ 8
quarters.
Finally, they ask us for the final value, F = ?

Development
First of all, we need to clarify what compound interest rate we will be working with. As we saw in class
Nominal interest rate (r) cannot be applied directly to calculations; for that, the effective interest rate must be determined.
(i) equivalent. Then:

The effective rate is the quotient of the nominal rate (annual) and the number of compounding periods that there are during
one year (x). One year has 4 quarters, so:

i=r/x i = 0.32 / 4 = 0.08 effective quarterly

The formula to calculate the final capital in compound interest is:

F = P (1 + i)
Replacing the data in the formula we have,

= 100.000 (1 + 0,08)8= 100.000 (1,8509) = 185.093

185.093

0 8
i = 0.08 quarterly

100,000
Mr. Pérez needs to have $300,000 within 6 months for his son's tuition payment. If a
The corporation offers you 36% annual with bi-monthly capitalization, how much would you have to deposit today to achieve your
objective?

Problem data
Mr. Pérez needs to have a capital (income) in the future F = 300,000. He is the one who makes the
financial analysis, not the financial corporation.
Nominal rate r = 0.36 annually, with bi-monthly compounding.
The deposit term is n = 6 months. Since the capitalization is bimonthly, the term of the problem also
It should be expressed in bimesters, so that n = 6 months ≈ 3 bimesters.
They ask us about the deposit that would need to be made today to accumulate a final capital, therefore, it
What they are asking us to do is calculate the initial capital P = ?

We proceed to calculate the effective rate. The number of bimesters in a year (x) is 6, then:

i=r/x i = 0.36 / 6 = 0.06 effective bimonthly

From the formula for calculating final capital (F), we isolate the initial capital (P):

F = P (1 + i) = (1+ )

Now we simply replace the data in the formula for P,

300.000 300.000 300.000

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Let us take the previous problem as a reference to illustrate cases where other variables are unknown.
financial. For example, let's assume a first case where under the same conditions posed by the exercise,
the unknown variable would be the term (n). The text would be as follows:

Mr. Pérez needs to have $300,000 by depositing $252,889 today in a corporation that offers him
an interest rate of 36% per year with bimonthly compounding. How much time should pass between the deposit
initial and final capital?

Problem data
- F = 300.000
- P = 252.889
i = 0.06 bimonthly cash
- n = ¿?

From the formula for calculating the final capital (F), we isolate the term (n). As it's an exponent, for
to clear it, one must use a property of the logarithmic function known to everyone, as follows:

F = P (1 + i) (1 + i) = n log (1+ i)=

Note: the logarithm of a power is equal to the exponent multiplied by the logarithm of the base. Since the
The equation poses an equality, then a logarithm is applied to both sides of the sign (=).
(continues)
n log (1+ i)= n = [log ]÷log (1 + i) (keep this formula in mind for cases of interest)
composed in which it is requested to calculaten)

Now we replace the data in the previous equation of n,

n = [log300.000]÷log (1 + 0.06) n = log 1.1863÷ log 1.06 n = 0.07418 ÷ 0.0253 = 2.93 ≈ 3

If the variable to be calculated were the text of the problem, it would be as follows:

Mr. Pérez needs to have $300,000 in 3 bimonthly periods by depositing $252,889 today in a
corporation during 3 bimonthly periods What would be the effective bimonthly interest rate recognized by the corporation?

Problem data
- F = 300.000
- P = 252.889
- n = 3 bimesters
- i = ? bimonthly effective

From the formula for calculating the final capital (F), we isolate the interest rate i.

3 3
F = P (1 + i) (1 + i) = 1+i= √/ i = [√/ ]–1

Now we replace the data in the previous equation of i,

3
i=[3300.000/252.889
√ ]–1 i = 1,18631
√ i = 1.06 - 1 = 0.06 bimonthly

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3. A property acquired three years ago is now worth $25,000,000. If the appreciation rate has been 28% per year.
What was the initial value of the property?

SOLUTION

The exercise provides the current value of a property and that value is taken as the basis for deducting, with the rate of
valuation, the initial value. It is then assumed that this is the initial capital (P), and that the current value of the property
it is the final capital (F) of the exercise. On the other hand, although the rate given to us is annual, we have no reason to
To think that it is a nominal rate because, as we know, nominal rates specify a period of capitalization.
Therefore, it is an annual effective rate and can be applied directly in the formulas.

Problem data
- F = 25.000.000
- i = 0.28 compound annual
- n 3 years
- P = ¿?

In a previous exercise, we had solved for the initial capital P, therefore, we use that same equation to
calculate the answer as follows:
 25.000.000 25.000.000
P= = 3
= 3
= 25.000.000 = 11,921,224
(1+ ) (1+0,28) (1,28) 2.0971

25,000,000

1 3
i = 0.28 annual

11,921,224