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11-2 Terms to be familiar with…
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Interest
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Interest
• Money charged for the use of money
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Principal
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Principal
• The amount of money initially invested
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Account Balance
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Account Balance
• Amount of money in the account at a given time
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Interest Rate
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Interest Rate
Percent charged annually a.k.a. APR
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Compound Interest
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Compound Interest
• Interest charged on interest
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Number of times interest is usually compounded
Annually Semi-annually
Quarterly Monthly Weekly Daily Continu-ously
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Number of times interest is usually compounded
Annually Semi-annually
Quarterly Monthly Weekly Daily Continu-ously
1
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Number of times interest is usually compounded
Annually Semi-annually
Quarterly Monthly Weekly Daily Continu-ously
1 2
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Number of times interest is usually compounded
Annually Semi-annually
Quarterly Monthly Weekly Daily Continu-ously
1 2 4
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Number of times interest is usually compounded
Annually Semi-annually
Quarterly Monthly Weekly Daily Continu-ously
1 2 4 12
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Number of times interest is usually compounded
Annually Semi-annually
Quarterly Monthly Weekly Daily Continu-ously
1 2 4 12 52
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Number of times interest is usually compounded
Annually Semi-annually
Quarterly Monthly Weekly Daily Continu-ously
1 2 4 12 52 365
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Number of times interest is usually compounded
Annually Semi-annually
Quarterly Monthly Weekly Daily Continu-ously
1 2 4 12 52 365 ∞
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Compounded Interest Formula
• A = • P = • n =• t =• r =
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Compounded Interest Formula
• A = Account Balance• P = • n =• t =• r =
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Compounded Interest Formula
• A = Account Balance• P = Principal• n =• t =• r =
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Compounded Interest Formula
• A = Account Balance• P = Principal• n = number of times in year interest is
compounded• t =• r =
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Compounded Interest Formula
• A = Account Balance• P = Principal• n = number of times in year interest is
compounded• t = time in years• r =
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Compounded Interest Formula
• A = Account Balance• P = Principal• n = number of times in year interest is
compounded• t = time in years• r = annual percentage rate (as a decimal)
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Compounded Interest Formula
A = P(1 + r/n ) (nt)
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Example1
• $1200 is invested at an APR of 9%. Find the balance in five years if the interest is compounded
• a) quarterly b) monthly
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$1200 is invested at an APR of 9%. Find the balance in five years if the interest is compounded
a)quarterly A =P = r = n = t =
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$1200 is invested at an APR of 9%. Find the balance in five years if the interest is compounded
a)quarterly A = ???P = 1200 r = .09n = 4t = 5
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A = 1200(1 + .09/4)(4 5)∙
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A = $1872.61
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$1200 is invested at an APR of 9%. Find the balance in five years if the interest is compounded
b)monthly A =P = r = n = t =
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$1200 is invested at an APR of 9%. Find the balance in five years if the interest is compounded
b)monthly A = ????P = 1200 r = .09n = 12t = 5
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A = 1200(1 + .09/12)(12 5)∙
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A = $1878.81
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Example2
• I would like to create a trust fund for my daughter that she can have in 18 years for college. I have $10,000 to invest. Which account would have a greater balance, one earning an APR of 6% compounded semiannually or one that earns an APR of 5.5% compounded daily?
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6% compounded semiannually
A = P = n =t = r =
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6% compounded semiannually
A = ???P = 10,000n = 2t = 18r = .06
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A = 10000(1 + .06/2)(2 18)∙
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A = $28,982.78
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5.5% compounded daily
A = P = n =t = r =
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5.5% compounded daily
A = ???P = 10,000n = 365t = 18r = .055
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A = 10000(1 + .055/365)(365 18)∙
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A = $26,910.33
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Example 3
• I would like to retire with a balance of $100,000 in an annuity. Find the amount of money to invest initially (principal) if I want to retire in 30 years and I can invest at an APR of 7% compounded weekly.
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7% compounded weekly
A = 100,000P = ???n = 52t = 30r = .07
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100000 = P(1 + .07/52)(52 30)∙
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100000 = P (1 + .07/52)(52 30)∙
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$12,262.95 = P
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Example 4
• At what interest rate do I need to invest $10,000 to double its value in 10 years if interest is compounded quarterly?
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A = 20,000P = 10,000n = 4t = 10r = ????
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20000 = 10,000(1 + r/4)(4 10)∙
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2 = (1 + r/4)(4 10)∙
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(2)1/40 = ((1 + r/4)(40) )1/40
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(2)1/40 - 1 = r/4
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4((2)1/40 – 1) = (r/4) 4∙
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4((2)1/40 – 1) = r
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r = 0.0699 = 6.99%