Compound Interest

Chapter 2
Describe the nature of compound interest;

and define the terms related to compound interest
computation;
Discuss how a compound interest is computed;
Calculate compound amount(F), time (t), rate (r) and

Present Value(P) in compound interest applications,
discuss equivalent rates and calculate rate equivalent

to a given rate;
calculate payment on any date that is equivalent to
one or more payments on other dates
Identify the relationship between nominal and

effective interest rates;
To better understand how Compound
Interest is calculated, let’s review how we
calculate Simple Interest!
Formula I = Prt
As we will now see, Compound Interest

uses the Sum of P & I as a base on which
to calculate new Interest!
Compound Interest
…Compound interest is interest on the principal plus the

interest of prior periods.
Compound Interest is interest added to the principal at the

end of a certain period of time after which the interest is
computed on the new principal, and this process is
repeated until the end of the term of the loan is reached.
COMPOUND INTEREST FORMULA
Let’s assume an investment of P1,000 at the interest rate of 6%
per annum compounded quarterly for 1 year.
Solution : conversion period is every 3 months(quarterly) thus

Interest is earned at the rate of 6%/4 = 1.5% per quarter
Amount of interest: At the end of the 1st quarter, we have a new

1st quarter: 1000* .015 = ₱15 principal equal to ₱1000 + ₱ 15 =
₱1015
Interest is now calculated on ₱ 1015

At the end of the 2nd quarter, we
have a new principal equal to
2nd quarter: I = 1015 *.015 = ₱15.225 ₱1 015 + ₱15.225 = ₱1 030.225
COMPOUND INTEREST FORMULA
Let’s assume an investment of P1,000 at the interest rate of 6% pa

Compounded quarterly for 1 year.
At the end of the 2nd quarter, we have a new principal equal to

₱1015 + ₱15.225 = ₱1030.225
3rd quarter: I = ₱ 1030.225 *.015 = ₱ 15.45
4th quarter: I = ₱ 1045.675 *.015 = ₱ 15.69
Compound Interest = ₱ 15 + ₱ 15.225 + ₱ 15.45 + ₱ 15.69

= ₱ 61.37
Compound Interest
Interest Interest Interest Interest
Amount ₱ 1000
1045.675 15.69
15.45 15.45
1030.225
15.225 15.225 115.225
1015
15 15 15 15
1000
1st quarter 2nd quarter 3rd quarter 4th quarter
0 1/4 2/4 3/4 4/4

Time(years)
Terms Related to Compounding of Interest
Nominal rate refers to The number of conversion

the rate of borrowing periods during a loan term is
and is usually quoted as also known as the
an annual interest rate, compounding period.
unless otherwise
specified.
Frequency or number of conversions refers to the
number of times the interest is added to the
principal in a year. The frequency of conversion in a
year may be monthly, quarterly, semi-annually, or
annually.
Nominal rate(j) refers The number of conversion

to the rate of borrowing periods during a loan term is
and is usually quoted as also known as the
an annual interest rate, compounding period.
unless otherwise
specified.
Frequency (m) or number of conversions refers
to the number of times the interest is added to the
principal in a year. The frequency of conversion in a
year may be monthly, quarterly, semi-annually, or
annually.
Compounding Frequencies and Periods
Frequency Period
Annually per year

Semiannually every 6 months
Quarterly every 3 months
Monthly every month
Daily per day
Semi-monthly twice a month(every quincena)
Bi-monthly every 2 months
Illustration: A loan with a term of 2 years will have
the ff total compounding periods
Period Frequency Term of the Total

(m) Loan compounding
(t) periods(t*m)
Annually 1 2 years 2
Semi-annually 2 2 years 4
Quarterly 4 2 years 8
monthly 12 2 years 24
Semi-monthly 24 2 years 48
Periodic rate or interest rate per compounding period (i)

refers to the interest per conversion period. It is equal to the
nominal rate divided the compounding period in a year.
Illustrative example
Julia plans to borrow a sum of money from a bank,
payable for three years. The bank is charging 12% interest
compounded quarterly. Determine the following:
1. Nominal rate of interest ( j)

2. Frequency (m)
3. Total number of conversion periods (n)
4. Periodic rate of interest (i)
The Compound Amount Formula
Let’s assume an investment of P1,000 at the interest rate of 6% pa
Compounded quarterly for 1 year.
Amount of interest: F1 = ₱1 000 + ₱ 15 = ₱1015

1st quarter: 1000* .015 = ₱15 F1= P + P*i
2nd quarter: F2 = ₱1 015 + ₱ 15.225 = ₱1030.225

I = 1015 *.015 = ₱15.225 F2= (P + P*i)*i+ (P + P*i)
= P(1+i)(1+i) = P(1+i)2
3rd quarter:
F3 = P (1+i)2 (1+i)
F3= P (1+i)3
Compound Amount Formula
F = P(1 + i)n
Where…
P= Present Value(Original Principal)

i = interest rate per period
n = number of periods
Example 1
Sherman deposited ₱10,000 in a savings account

for 5 years at a rate of 15% compounded semiannually.
How much is Sherman’s interest and compounded
amount?
Solution
Solve for : Compound Interest (I) and compound Amount ( F)
Given: P = 10,000, t = 5 , j = 15 % compounded semi annually
Formula to use: F = P(1 + i)n

j = 15 % compounded semiannually implies that i = 15%/2 = 7.5% or
0.075
t = 5 implies that n = t *m
n = 5 *2
n = 10
Example 1
Sherman deposited ₱10,000 in a savings account for

5 years at a rate of 15% compounded semiannually.
How much is Sherman’s interest and compounded
amount?
Solution
Solve for : Compound Interest (I) and compound Amount ( F)
Given: P = 10,000, n=10 , i = 0.075
Formula to use: F = P(1 + i)n F = 10,000 (1 + 0.075)10
F = ₱ 20,610.32
I= F–P I = ₱ 20,610.32 –₱10,000
I = ₱10,610.32
Example 2
Sarah invested ₱ 15,000 for 8 years and 7 months at

10% compounded quarterly. Determine the compound
amount.
Solution
Solve for : compound Amount ( F)
Given: P = 15,000, t = 8 years and 7 months , j = 10% compounded
quarterly
Formula to use: F = P(1 + i)n t = 8 + 7/12 = 103/12
m= 4
Extract necessary data... n = 103/12 X 4 = 103/3
i = .10/4 = .025
Example 2
Sarah invested ₱ 15,000 for 8 years and 7 months at

10% compounded quarterly. Determine the compound
amount.
Solution
Solve for : compound Amount ( F)
Using P = ₱ 15 000 n = 103/3 i= .025
F = ₱ 15 000(1 + .025)103/3
= ₱ 15 000(2.334457894)
= ₱ 35,016.87
Find the amount due at the
end of 3 years and 6 months
on ₱ 35, 000 at 12%
compounded monthly.
Accumulate ₱ 20 000 for 50

years
(a) at 6% compounded
annually
(b) at 6% simple interest.
Compound Interest
What happens if the interest rate

changes during the life of an
investment?
Both creditor and debtor may agree to change the

interest rate during the term of borrowing, if the debtor
settles the obligation before the due date or request for
extension of borrowing terms. Similarly, the interest
rates of bank deposits or investments may vary
because of changes on previously agreed terms or
implementation of new monetary policy.
Example 1
Ms. Zulueta invested ₱ 10,000 for 20 years. The terms are as
follows: in the first 5 years, the interest rate is 10% compounded
quarterly; then it will be 12% compounded semi-annually for the
next 7 years; and 14% compounded annually for the remaining
years. Determine the compound amount at the end of 20 years.
Solution
Solve for : compound Amount ( F) at the end of 20 years
Remaining Years
1st 5 years Next 7 years
F= ₱ 37,047.53 *
P = ₱ 10 000 P = ₱ 16 386.16 8
(1 + .14)
F1 = ₱10 000 * (1+.10/4)20 F2= 16386.16 (1+.12/2)14
= ₱ 16 386.16 = ₱ 37,047.53
Ms. Zulueta invested P10,000 for 20 years. The terms are as follows: in
the first 5 years, the interest rate is 10% compounded quarterly; then it
will be 12% compounded semi-annually for the next 7 years; and 14%
compounded annually for the remaining years. Determine the
compound amount at the end of 20 years.
Solving 10 000(1.025)20 (1.06)14(1.14)8

Alternative
= ₱ 105,681.32
Solve for
all 20 years
at once!
It is rare for interest to be
compounded only once per
year!
8 - 26
The concept of
compound To discount an amount
amount F for n conversion Let I be the
focuses on the periods means to find discount on F,
determination its present value P on a then .
of the future day which is n periods
value of the before F is due. I=F-P
principal.
8 - 27
REMARK
So we use to accumulate P
And to discount a future value F
Because of this
(1 + i )
n
Is called the accumulation factor
(1 + i )
−n
Is called the discounting factor
8 - 28
Richard plans to raise ₱300,000
in 3 years. Discount the amount at
12% compounded quarterly.
Solution
Solve for: P Given : F = ₱300,000, t = 3 years, j =12%,
and m = 4
Formula to use: P = F (1+i) – n
Substituting the given values Using your

gives calculator P = ₱210,413.96
P = 300,000 (1+00.03) – 12 gives
Find the present value on January
1, 2010 , of ₱ 10 000 due on
January 1,2017 at 5.5%
compounded semiannually.
Solution
Given : F = ₱10,000, t = 7 years, j =5.5%,
Solve for: P
and m = 2
•Substituting the given

values in the formula yields P =₱6, 839.97
•Using a
P = 10,000 (1+0.0275) – 14 calculator
How much must a man 36 years of age
deposit in a savings account today , in a
bank paying 4 ½ % compounded
quarterly, in order to have ₱ 250, 000
in the account 25 years from now.
Solution
Given : F = ₱250,000, t = 25 years, j =4.5%, and m = 4
Solve for: P
Substituting the
given values in the P = 250,000 (1+0.01125) – 100 P = ₱81,674.51
formula yields
Discount ₱ 80,00 for 6 years and 5
months at 8% compounded
quarterly
Solution Formula to use: P = F (1+i) – n
Solve for: P
Given : F = ₱80,000, t = 6 years & 5 months, j =8 %, and m = 4
5 65 65
n=6 𝑥4 = 𝑥4 =
12 12 3
Substituting the P = ₱52,089.82

P = 80,000( 1+.02) – 65/3
values in the formula
P = F (1+i) – n

Compound Interest

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Compound Interest

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Chapter 2

Describe the nature of compound interest;

Discuss how a compound interest is computed;

Calculate compound amount(F), time (t), rate (r) and

discuss equivalent rates and calculate rate equivalent

Identify the relationship between nominal and

As we will now see, Compound Interest

…Compound interest is interest on the principal plus the

Compound Interest is interest added to the principal at the

Solution : conversion period is every 3 months(quarterly) thus

Amount of interest: At the end of the 1st quarter, we have a new

Interest is now calculated on ₱ 1015

Let’s assume an investment of P1,000 at the interest rate of 6% pa

At the end of the 2nd quarter, we have a new principal equal to

3rd quarter: I = ₱ 1030.225 *.015 = ₱ 15.45

4th quarter: I = ₱ 1045.675 *.015 = ₱ 15.69

Compound Interest = ₱ 15 + ₱ 15.225 + ₱ 15.45 + ₱ 15.69

1st quarter 2nd quarter 3rd quarter 4th quarter

0 1/4 2/4 3/4 4/4

Nominal rate refers to The number of conversion

Nominal rate(j) refers The number of conversion

Annually per year

Period Frequency Term of the Total

Periodic rate or interest rate per compounding period (i)

1. Nominal rate of interest ( j)

Amount of interest: F1 = ₱1 000 + ₱ 15 = ₱1015

2nd quarter: F2 = ₱1 015 + ₱ 15.225 = ₱1030.225

P= Present Value(Original Principal)

Sherman deposited ₱10,000 in a savings account

Formula to use: F = P(1 + i)n

Sherman deposited ₱10,000 in a savings account for

Formula to use: F = P(1 + i)n F = 10,000 (1 + 0.075)10

I= F–P I = ₱ 20,610.32 –₱10,000

Sarah invested ₱ 15,000 for 8 years and 7 months at

Sarah invested ₱ 15,000 for 8 years and 7 months at

Using P = ₱ 15 000 n = 103/3 i= .025

Accumulate ₱ 20 000 for 50

What happens if the interest rate

Both creditor and debtor may agree to change the

Solving 10 000(1.025)20 (1.06)14(1.14)8

And to discount a future value F

Formula to use: P = F (1+i) – n

Substituting the given values Using your

Formula to use: P = F (1+i) – n

•Substituting the given

Given : F = ₱80,000, t = 6 years & 5 months, j =8 %, and m = 4

Substituting the P = ₱52,089.82

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