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Compound Interest
Lesson 3.5
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Agree or Disagree ?
• A bank account that pays 12% per year yields the same results as a bank account that pays 1% every month and compounds interest.
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Nominal vs. Effective Rate
• Nominal rate The stated yearly rate "12% compounded monthly"
• Effective rate The result of the compounding 12% compounded monthly actually gives a
12.683% return on your investment
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Compound Interest Formula
• Actually we saw this in the previous lesson
• Here r = the nominal rate
Then is the decimal for the effective rate
1n t
rB P
n
1n
r
n
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Periodic vs. Continuous
• Note the similarities between periodic compounding
and continuous compounding
1n t
rB P
n
k tB Pe
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Periodic vs. Continuous
• The k in the continuous model will always be similar or close to the r value in the periodic compounding model
• Generally r must be slightly larger because there are "less" compounding periods per year
• Example Convert B = P e .05t to periodic Convert 7.25% compounded monthly to
continuous form
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Assignment
• Lesson 3.5
• Page 139
• 1 – 21 odd