COMPOUND INTEREST

In compound interest, the interest is added to the capital, it is said that it is

capitalizableo convertible to capital. The interest will increase periodicallyythe capital
also.

The sum due at the end of the operation is called compound amount.

Compound interest is the difference between the compounded amountythe capital

original.

The difference between simple interest and compound interest is that the former is
for a period in the compound is for a number n of periods

Example 6-1:

Find the compound amountythe compound interest of $4000 for 3 years

at 6% convertible annually.

We make a diagram for 3 years.

O 1 2 3 years

4000 1 2

Original Capital = 4000 lc =4764.06 - 4000

Interest for 1 year 4000 (0.06) (1) = 240 lc=746.06
Nuevo capital al cabo of 1 year = 4240
Interest for 1 year 4240(O.06) (1) = 254
Nuevo capital al cabo de dos años = 4494.4
Interest for 1 year 4494.4 (0.06)(1 = 269.66
New capital after 3 years = $4764.06 (Compound amount).
 The new capital after 3 years is the compounded amount, it is observed that the capital
increases as follows. 4000, 4240, 4494.4, etc. And logically the interest as well.

DEFINITION OF THE ELEMENTS INVOLVED IN THE CALCULATION:

Conversion frequency (m), for each period (i)

The interest can being converted to capital: annually,

["biannually","quarterly","every four months","monthly","etc."]

And the time interval between two successive conversions is called the period of
conversionoof interest.

Examples

If it is 6% convertible annually the frequency m=1 (one time)

If it is 12% convertible quarterly, the frequency is m=3.

If it is 7% convertible semi-annually, the frequency is m=2

 It is advisable that in order to achieve greater mastery in later Exercises the
greater understanding of the following table.

Frequency of So much for Decimal # of Number of

Nominal amount(j) conversion (m) period (i) years Periods (n)
(H)
8% convertible 2 4% 0.04 8 16
semester
b) 6% convertible .-- 3 2% 0.02 6 18
four-month
c) 12% convertible 12 1% 0.01 4 48
monthly.
d) 6% convertible 12 Y2 % 0.005 3 36
monthly
e) 7 %convertible 2 3 Y2 % 0.035 10 20
semesterly
3% convertible 4 %% 0.0075 8 32
quarterly

In this table called nominal rate, it is the rate given in the exercise.
The conversion frequency m is calculated by dividing j by m in each case: by
example. In a) j =8%, m =2 then i =jlm
8o/of2= 4%.

Also in each case.

The frequency m is calculated as follows:

I am= 8% convertible semiannually m = 2 (twice a year)

j=4% convertible quarterly m = 4 (Four times a year)
etc.

An important variable is the number of periods (n) that are calculated.

always

n = frequency x # of years

H: number of years
n=mxH
 Example 6-2:

Complete the following table:

So normal Frequency of So much for Decimal # de Number of

conversion period (i) years periods
m n
6% convertible 4
monthly
4% convertible 8
quarterly
4% convertible 3
monthly ..
7% convertible 5
quarterly
3 % convertible 8
semiannually
12 % convertible 6
quarterly

CALCULATION OF COMPOUND AMOUNT:

If a capital is investedCThe interest for the period is Ci

ythe amount will be: S1=C +C;
S1C(1 = + capital
i) new

That if it generates interest for one more period would be

I = C (1 + i) i
I = Ci (1 + i) is the interest where we add it to the previous capital.
S2 =
C(1+i)+Ci(1+i)
S2 =
(C+Ci) (1+i) Factoring
S2=C(1+i)(1+i)
S2 = C(1 + i)^2

13 = C (1+i) squared
Added to the previous capital will be:

S3 = C(1+i)² + Ci (1+i)²
S3 = (C +Ci) (1 +i)2 .
S3 =
C (1+i) (1+i)2
S3 = e ( 1+iJ 3
 If we continue to generate interest for n periods, we would conclude that:

s = c(1+i)n
Reference:

compound interest
C: Original capital
It is for a period
n: number of periods n.

Example6-3:

1. Find the compound amount of 4000 over 3 years at 6% convertible.

annually.

S =?
e =4000 S= c(1+i)n
j = 6% annually s=4000 (1+ 0.06)3
m=1 , s= 4000(1.06)3
i = 6% = 0.06 s = 4000 (1.191016)
n=1x3 s = 4764.06
n=3

Note that the same result as example 6-1

Example 6-4:

Find the amount of $3200 at 12% convertible quarterly during5 years.

S= c(1+i) n
s = e =3200
s=3200 (1+0.04)^15
j = 12% Quarterly
m=3 s = 3200 (1.04)15
I = 4% = 0.04 ' S=3200( 1.800943)
n=3x5 S=5763.02
n=15

Example 6-5:

' A person invests 10,000 in a company that pays 1 % convertible

monthly; what amount will the person have? a the 6 years.
S= ?
e = 10,000 i = 1% = 0.08333%
j=1% Monthly Convertible 12
m = 12 i = 0.0008333
S=10,000 (1 + 0.000833)72
s=10,000(1.000833)72
S=10,000 (1.061785)

s = 10618.10
n = 12X6 n = 72
Example 6-6:

Calculate the compound amount of $1000 at 7% compounded semiannually for

4 years and 6 months

S= ? S= c(1+i) n
c = 1000
j7% Convertible Semiannually s = 1000 (1 + 0.035)9
m=2 i = 7%12 s = 1000 (1.035)9
n = 2 x 4 _6_ S = 1000 (1.362898)
12
n= 2 X 9/2 i = 3.5% S= 1362.9

n=9 i = 0.035

I = 0.035

Example 6-.7:

What will be the amount of $1,300.00 at 5% convertible quarterly during 8 yearsy

2 months?
c= $1,300
j = 5% Quarterly Convertible n = 2 x 49 S= c(1+i)n
m=4 3 S = 1300(1 + 0.0125)^3·2 67

=
i 5%14 = n = 98 S = 1300 (1.0125)35 67 ·
=
i 1.25% = 0.0125 3 S= 1300 (1.500568)
n = 4 x 8_2 n = 32.67 S= 1950.74
12
n= 4X8_1
6
n=,4 x 49
6

REALIZE

Example6-8:

Accumulate $8000.00 at 8% convertible semi-annually for 6 years.

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 Example 6-9:

Accumulate $6200.00 for 8 years at 4.2% convertible:

Quarterly.
b)Semestralmente

Example 6-10:

Accumulate $3500.00 at 12% compounded quarterly for 5 years.

Example 6-11:

Find the compound amount of $2600.00 at 5% convertible semi-annually.

for 4 years.

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Example6-12:

A person invests $12,000 in an account that pays 6% interest compounded.

monthly, how much will it beathe 5 years?

Example 6-13:

Halleel montocompuest of $6000.00 for 5 years and 4 months at 8%

convertible quarterly

Example 6-14:

Calculate the compounded amount of $2000.00 at 6% convertible quarterly.

for 6 yearsy1 month.

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 NOMINAL INTEREST RATE AND EFFECTIVE INTEREST RATE:

Nominal rate is the rate at which interest is converted to capital more than once.
once a year

Example:
a) 8% convertible semiannually (2 times)
b) 12% convertible monthly (12 times)

Effective rate (i): it converts only once a year.

Example:
12% convertible..annually (1 time)
b) 6% convertible annually (1 time)

When are the rates equivalent?Two annual rates with different

conversion periods are equivalent when they produce the same interest
compound interest amount at the end of a year.

Example 6-13:

Find the equivalent effective rateaa rate j of 6% convertible

semiannually.
For a clearer approach, take it in two parts. y equal wolf.
i=? j = 6% semiannually (1+i) = (1 + 0.03)²
m=1 m=2 1 + i = (1.03)2
n=1 i=O.03 1+i=1.0609
n = 1X 2 i = 1.0609-1
n=2 i = 0.0609
i = 6.09%
TheI have concluded that:
6.9% effective [Link] equivalent a 6% convertible semiannually.
Let's prove that they produce the same amount.

I Example 6-14:

Calculate the compound amount of 2,000 at 6.09% effective for 4 years.

S =? S= c(1+i)n
j = 0.0609 s =2,000 (1+0.0609)4
m= 1 s =2,000(1.0609)4
i = 0.0609 s = 2,000(1.266770)
n = 1x 4 s = 2533.54
n=4
e = 2.000
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 a) Find the compound amount of 2,000 at 6%, compounded semiannually for 4 years.
years.
S =? S= c(1+i)n
j=6% semiannually S=2,000 (1+0.03)8
m=2 S=2,000(1.03)8 observe in 6.14oh
i = 3% = 0.03 S=2,000(1.266770) 6.14 b are equal.
n=2x4=8 2533.54 .s
Example 6-15:

What nominal interest rate converted quarterly is equivalenta6%

convertible monthly.
As in the previous example, take it in two parts.

j=convertible quarterly. 6% convertible monthly.

m=3 m = 12 3
(1+jj=(1.005)1 2
i = j / 3 i=0.005 3
n = 1 X 12 (1+jj 1.061678
3
n=1x3 n=12 3

n=3 (1+i)n
(1+jj3 (1.005)12 3
3
1 + j_ = 1.02015
3
j_ = 0.02015
3
j = (0.02015) (3)
j = 6.04%
Convertible
Quarterly.
Example 6-16:

Calculate Y and Test the Results.

What nominal rate convertible monthly is equivalenta4% convertible

trimetral rent?

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Example 6-17:

What annual rate i is equivalent to 7% convertible semi-annually?

OBSERVATION

ANOTHER IMPORTANT TEXT IS CHAPTER 3 OF THE BOOK CISSELL AND CISSELL

105
PROPOSED EXERCISES:

1. Find the Compound amount of:

$8500 at 8% convertible semiannually for 6 years

$2500 at 6% convertible quarterly for 8 years

$3000 at 12% convertible quarterly for 6 yearsy

three months

$2000 at 3% convertible semiannually for 8 years and

5 months.

Resp.: a) $13608.77 $4021.09

c)$6281.33 $2673.3

According to the 1993 Census, the population of a municipality was 50,000 inhabitants. If
The growth of this population is considered constant (4% annually).
How many inhabitants will it have by the year 2005.
Reply: 80,052 inhabitants.

3. In a commercial establishment, sales have increased significantly.

constant (3% annually). If the sales volume for the year 1990 was
$200,000.00, what would be the sales volume for the year 2008?
$340,486.6

On the day a girl was born, her father invested $20,000.00 in a fund.
that pays 5% convertible semi-annually. How much will be available?
When will I turn 18?
Resp.: $53,109.96

5. What nominal rate convertible quarterly is equivalent?a8%

convertible quarterly?
Resp.: j = 8.02 Quarterly.

6. What effective annual rate is equivalent

a 5% semi-annually convertible?
Resp.: i=5.06% anualmente.

[Link] monthly convertible rate is equivalent a 5% convertible

quarterly?
Resp.: j = 4.98% Monthly.

8. What nominal rate convertible semi-annually is equivalent a12%

convertible monthly?
Resp.: j = 12.32% Semiannually.

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