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    Chapter 2 - Multiple Compounding Periods

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    SatyendraKumar

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    © All Rights Reserved
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    Chapter 2 - Multiple Compounding Periods

    Uploaded by

    SatyendraKumar
    53 views7 pages

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    Copyright:

    © All Rights Reserved
    Download as PPTX, PDF, TXT or read online from Scribd
    Download as pptx, pdf, or txt
    53 views7 pages

    Chapter 2 - Multiple Compounding Periods

    Uploaded by

    SatyendraKumar

    Copyright:

    © All Rights Reserved
    Download as PPTX, PDF, TXT or read online from Scribd
    Download as pptx, pdf, or txt
    of 7

    Multiple Compounding Periods

     Interest factor formulas assume that the cash


    flow period and the compounding period match.
    Interest rate used must be for this common
    period.
    – EOY cash flows and interest compounded annually;
    use annual interest rate
    – Quarterly cash flows and interest compounded
    quarterly; use quarterly interest rate
    – Monthly cash flows and interest compounded
    monthly; use monthly interest rate

    Copyright 2019 John Wiley & Sons, Inc .


    Nominal Interest Rate
     Nominal interest rate/year: the annual interest rate
    w/o considering the effect of any compounding during
    the year.
    – 12%/year
     Interest rate/period =
    Nominal interest rate/year
    Number of compounding or interest periods/year

    – Monthly compounding - (12%/year)/(12 months/year) =


    1%/month
    – Quarterly compounding - (12%/year)/(4 quarters/year) =
    3%/quarter
    – Annual compounding - (12%/year)/(1 year/year) = 12%/year
    Copyright 2019 John Wiley & Sons, Inc .
    Example 2.19—Determining Car
    Payments
    Rebecca Carlson purchases a car for $25,000 and
    finances her purchase by borrowing the money at 8% per
    year compounded monthly; she pays off the loan with
    equal monthly payments for 5 years. What will be the size
    of her monthly loan payment?
    Given: P = $25,000; nominal annual interest rate =
    8%/year; duration of loan = 5 years; number of interest
    periods/year = 12 months/year
    Find: Period interest rate; number of interest periods; A

    Copyright 2019 John Wiley & Sons, Inc .


    2-3
    Example 2.19—Determining Car
    Payments (cont.)

    8% / year
    Period Interest Rate   0.66667% / month
    12 months / year

    Number of Interest Periods = 5 years (12 months/year) =


    60 months

    0.0066667  1.0066667 
    60

    A = $25, 000  A | P 0.66667%, 60  = = $506.91/ month


     1.0066667 
    60
    1

    Copyright 2019 John Wiley & Sons, Inc .


    2-4
    Effective Annual Interest Rate

    The effective annual interest rate is given by the


    formula:
    ieff   1  r / m   1  EFFECT  r , m 
    m

    where r = nominal annual interest rate


    m = number of compounding or interest periods per year

    Copyright 2019 John Wiley & Sons, Inc .


    Example 2.20—Calculating the
    Effective Annual Interest Rate

    Calculate the effective annual interest rate


    for each of the following cases:
    (a) 12% per year compounded quarterly
    (b) 12% per year compounded monthly
    (c) 12% per year compounded every minute

    Copyright 2019 John Wiley & Sons, Inc .


    2-6
    Example 2.20—Calculating the Effective
    Annual Interest Rate (cont.)

    a. Twelve percent per year compounded quarterly: r = 12%; m = 4.


    ieff = (1 + 0.12/4)4 – 1
    = (1.03)4 – 1
    = 0.12551 = 12.551%
    b. Twelve percent per year compounded monthly: r = 12%; m = 12.
    ieff = (1 + 0.12/12)12 – 1
    = (1.01)12 – 1
    = 0.12683 = 12.683%
    c. Twelve percent per year compounded every minute: r = 12%; m =
    525,600 minutes.
    =  1  0.12/525, 600
    525,600
    ieff 1
    = 0.12749684 = 12.749684%

    Copyright 2019 John Wiley & Sons, Inc .


    2-7

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