LESSON 4.

1 Number of Conversion Period (n) – this is the

total number of compounding period in a year
for the whole investment term obtained in
Usually, the interest paid on money multiplying the time (or term) by the number
deposited or borrowed is compound interest. of compounding period per year (m).
The interest earned each period of time n = term x number of compounding period
keeps increasing. This is the effect of per year
compound interest.
n = tm or n = mt
Compound interest is calculated on the
original principal and the interest previously Example:
earned by an account. This means that a sum The term of the loan is 5 years compounded:
of money invested for one year that earns
interest compounded monthly will earn
simple interest for the first month of the total
period.

The interest is added to the original

principal to have a new principal. This new Periodic Rate or Interest rate per period (i) –
principal now becomes the basis for this is the rate of interest per conversion
calculating the interest for the second month, period. interest rate per compounding period
and the process is repeated until the last obtained in dividing the nominal interest rate
month of the period. In other words, a (j) by the number of conversion period per
compound interest is the interest on the year or the frequency of conversion (m).
principal and the interests of previous periods. Periodic Rate = nominal interest rate ÷
𝒋
Interest may be compounded periodically period per year 𝒊=
𝒎
such as monthly, quarterly, semi-annually, or
Application:
annually over the life of the investment or
loan. Compound interest is usually used by The interest rate is 7% compounded:
banks or individuals in calculating interest for
long-term investments and loans. a) Annually 7% ÷ 1 = .07 or 7%
b) Semiannually 7% ÷ 2 = .035 or 3.5%
Compounding Periods or the frequency of c) Quarterly 7% ÷ 4 = .0175 or 1.75%
conversion (m) – the frequency of conversion d) Monthly 7% ÷ 12 = .0058 or .58%
period for computing interest at regular stated
intervals, expressed by length of time and The more frequent the compounding
taken as an exact division of the year such as: periods, the more interest the principal
earns. Say, the interest that had been
Annually (1) - once a year or every year compounded quarterly rather annually, the
Semiannually (2) - twice a year or every six interest have earned been greater.
months
Quarterly (4) - four times a year or every three Nominal Rate (j)– This is the stated rate of
months interest per year.
Monthly (12) - 12 times a year or once a/every Example: 5% means 5% is the nominal rate
month per year.
Daily - everyday or 365 times in a year
Finding the Compound Amount and Step 3. Using the formula F = P(1 + i)n
Compound Interest
F = 10,000(1 + .03)6
❀ The compound amount or future value is F = Php 11,940.52
the final amount of the investment or loan at
Finding the Nominal Interest Rate
the end of the term.
❀ In problem when the interest rate is being
The Compound Amount Formula:
asked while values for other variables are
F = P (1 + i)n stated, the compound amount formula may
be restated as:
where:
F = Compound Amount or Future Value (1 + i)n = F ÷ P
P = Present Value or Principal
i = Interest rate per period Application:
n = Total compounding periods 1. What is the interest rate compounded
i)n
Note that factor (1 + is called the accumulation annually if Php10,000 will accumulate to
factor for compound interest. Php50,544.70 in 17 years?
The compound interest (Ic) is the difference
Solution:
between the compound amount (F) and the
(1 + i)n = F ÷ P
original principal (P).
where n = 17 years x 1 (annually) and i =
Ic = F − P 10%.
Example: (1 + i)17 = 50,544.70 ÷ 10,000
Solving for I,
1. Compute for the compound amount of i = 10%.
Php10, 000 invested at 6% interest
compounded semi-annually for 3 years.

Solution:

Step 1. Periodic Rate = Nominal Interest Rate

÷ periods per year

i=j÷m
i = 6% ÷ 2
i = .06 ÷ 2
i = .03

Step 2. Total number of conversion periods

per year = time multiply by the compounding
period per year

n=txm
n = 3 years x 2
n=6
LESSON 4.2

🌃 Understanding how to calculate

compound interest is important for
predicting investment performance, The process for calculating compound
whether it’s for retirement planning or your interest is easy, but if you want to figure out
personal portfolio, and Excel is an excellent the value of your investment after 10 years,
tool to do so. for example, this process is not efficient.
Instead, you could use a generalized
1. If you are investing PHP1,000 with a 15% compound interest formula.
interest rate, compounded annually, below is
how you would calculate the value of you
investment after one year.

2. In this case B2 is the principal, and A2 is General Compound Interest Formula (for
the Interest Rate per Period. The “$” is used Daily, Weekly, Monthly, and Yearly
in the formula to fix the reference to column Compounding)
A, since the interest rate is constant in this
example. ❥ A more efficient way of calculating
compound interest in Excel is applying the
You can calculate the value of your general interest formula: F = P(1+i) n, where F
investment after two years by simply copying is future value, P is present value, i is the
and pasting the formula into cell D2, as interest rate per period, and n is the number
shown below. of compounding periods.

Say, for instance that you are investing P

5,000 with a 10% annual interest rate,
compounded semi-annually, and you want to
figure out the value of your investment after
3 C2 is the current gross figure. Notice how five years. The spreadsheet below shows
B2 automatically changes to C2, since the how this calculation can be done on Excel.
cell reference has changed. You could copy
the formula over additional columns to
calculate the compounded value in future
years. We would recommend structuring a
table like this (vertically instead of
horizontally):
☆ type (optional) indicates when additional
payments occur. “0” indicates that the
payments occur in the beginning of the
period, and “1” indicates that the payments
are due at the end of the period.
﹋﹋﹋﹋﹋﹋﹋﹋﹋﹋﹋﹋﹋﹋﹋﹋﹋﹋
The previous semi-annual compound
In this case, P is the Principal, i is (Annual interest example can be completed with the
Interest Rate) / 2 because interest is FV function.
compounded semi-annually (twice per year),
n is (Compounding Periods per Year) x (Year),
and F is the Investment Value. This process is
more efficient than the first one because you
don’t have to calculate the gross figure after
each period, saving quite a few calculation
steps.

FV Function and Compound Interest

“rate” is (Annual Interest Rate) /
╰┈➤ Lastly, you can calculate compound (Compounding Period per Year)
interest with Excel’s built-in Future Value
Function. Similar to the previous process, “nper” is (Compounding Periods per Year) x
the FV function calculates the future value of (Years),
an investment based on the values of certain “pmt” is 0, and
variables.
“pv” is – (Principal).

The variables are:

☆ rate is the interest rate for each period.
☆ nper is the number of compounding ◨ Understanding how to calculate
periods. compound interest is important for
☆ pmt is the additional payment per predicting investment performance,
period, and it is represented as a negative whether it’s for retirement planning or your
number. If there is no value for “pmt,” put a personal portfolio, and Excel is an excellent
value of zero. tool to do so.

☆ pv (optional) is the principal investment,

which is also represented as a negative
number. If there is no value for “pv,” you
must include a value for “pmt.”