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Note for Compound Interest - CI by Placement Factory

  • Compound Interest - CI
  • Note
  • Quantitative Aptitude
  • Placement Preparation
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Example: A principal of €25000 is invested at 12% interest compounded annually. After how many years will it have exceeded €250000? 10 P = P (1 + r ) n Compounding can take place several times in a year, e.g. quarterly, monthly, weekly, continuously. This does not mean that the quoted interest rate is paid out that number of times a year! Assume the €500 is invested for 3 years, at 10%, but now we compound quarterly: Quarter interest earned amount at end of quarter 1 12.5 512.5 2 12.8125 525.3125 3 13.1328 538.445 4 13.4611 551.91 Generally: r⎞ ⎛ S = P ⎜1 + ⎟ ⎝ m⎠ nm

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where m is the amount of compounding per period n. Example: €10 invested at 12% interest for one year. Future value if compounded: a) annuallyb) semi-annuallyc) quarterly d) monthly e) weekly As the interval of compounding shrinks, i.e. it becomes more frequent, the interest earned grows. However, the increases become smaller as we increase the frequency. As compounding increases to continuous compounding our formula converges to: S = Pe rt Example: A principal of €10000 is invested at one of the following banks: a) at 4.75% interest, compounded annually b) at 4.7% interest, compounded semi-annually c) at 4.65% interest, compounded quarterly d) at 4.6% interest, compounded continuously

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=> a) 10000(1.0475) b) 10000(1+0.047/2)2 c) 10000(1+0.0465)4 d) 10000e0.046t

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Example: Determine the annual percentage rate of interest of a deposit account which has a nominal rate of 8% compounded monthly. 1*12 ⎛ 0.08 ⎞ ⎜1 + ⎟ 12 ⎝ ⎠ = 1.0834 Example: A firm decides to increase output at a constant rate from its current level of €50000 to €60000 during the next 5 years. Calculate the annual rate of growth required to achieve this growth. 50000 (1 + r ) = 60000 5

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