Section 5.

2, Compound Interest
Dr. Antara Mukherjee

January 17, 2012

Dr. Antara Mukherjee

Section 5.2, Compound Interest

Denition

The future value of an investment of PV dollars earning interest at an annual rate of r compounded m times per year for a period of t years is, r FV = PV (1 + m )mt or, FV=PV(1 + i)n , where i =
r m

and n = m t

Given the Future Value, rate of interest etc., the Present Value can be computed in the following way, PV =
FV (1+i)n

Dr. Antara Mukherjee

Section 5.2, Compound Interest

Example

Problem # 4, page 364 Find the FV when PV=$ 10,000 at 1.5% interest compounded weekly after t = 5 years.

Dr. Antara Mukherjee

Section 5.2, Compound Interest

Example

Problem # 4, page 364 Find the FV when PV=$ 10,000 at 1.5% interest compounded weekly after t = 5 years. Solution: Given PV=$10000, r =0.015, m =52, t =5 years, FV =10000(1 +
0.015 525 52 )

FV = $10,778.73

Dr. Antara Mukherjee

Section 5.2, Compound Interest

Example

Problem # 12, page 364 Find the PV which will be worth FV=$ 1000 after t = 10 years, at 5.3% per year compounded quarterly.

Dr. Antara Mukherjee

Section 5.2, Compound Interest

Example

Problem # 12, page 364 Find the PV which will be worth FV=$ 1000 after t = 10 years, at 5.3% per year compounded quarterly. Hint: Use the following formula for Present Value, FV PV = (1+i)n , then check whether PV =$ 590.66.

Dr. Antara Mukherjee

Section 5.2, Compound Interest

Denition

Eective Interest Rate re of an investment paying a nominal interest rate of rnom compounded m times per year is: re = (1 +
rnom m m )

Dr. Antara Mukherjee

Section 5.2, Compound Interest

Example

Problem # 18, page 364 Find the eective annual interest rate of the given annual interest rate of 10% compounded daily. (Give your answer rounded to the nearest 0.01%)

Dr. Antara Mukherjee

Section 5.2, Compound Interest

Example

Problem # 18, page 364 Find the eective annual interest rate of the given annual interest rate of 10% compounded daily. (Give your answer rounded to the nearest 0.01%) Solution: re = (1 + re = (1 +
0.1 365 365 ) rnom m m )

1,

re = 0.1052 Final Answer: The Eective Interest Rate is 10.52%

Dr. Antara Mukherjee

Section 5.2, Compound Interest

Applications

Problem # 24, page 364 Depreciation During 2008, Fidelitys Nasdaq Composite Fund depreciated 42%. Assuming that this trend were to continue, how much would a $5000 investment in the fund be worth in 4 years?

Dr. Antara Mukherjee

Section 5.2, Compound Interest

Applications

Problem # 24, page 364 Depreciation During 2008, Fidelitys Nasdaq Composite Fund depreciated 42%. Assuming that this trend were to continue, how much would a $5000 investment in the fund be worth in 4 years? Solution: Given PV =$5000, t =4 years, r =0.42, m =1 now use the formula FV = PV (1 r )t to compute the Future Value (FV).

Dr. Antara Mukherjee

Section 5.2, Compound Interest

Applications

Problem # 28, page 364 Investments When I was considering what to do with the $10,000 proceeds from my sale of technology stock, my broker suggested I invest half of of it in municipal bonds, whose value was growing by 6% per year and the other half in CDs, which were yielding 3% per year, compounded every 2 months. Assuming that these interest rates are sustained, how much will my investment be worth in 10 years?

Dr. Antara Mukherjee

Section 5.2, Compound Interest

Applications

Problem # 28, page 364 Investments When I was considering what to do with the $10,000 proceeds from my sale of technology stock, my broker suggested I invest half of of it in municipal bonds, whose value was growing by 6% per year and the other half in CDs, which were yielding 3% per year, compounded every 2 months. Assuming that these interest rates are sustained, how much will my investment be worth in 10 years?

Dr. Antara Mukherjee

Section 5.2, Compound Interest

Applications
Solution: Solve using TVM Solver of your calculator. The TVM Solver is found under the APPS button on the TI-83, Municipal Stock CDs N = 10 N = 60 I% = 6 I% = 3 PV = 5000 PV = 5000 PMT = 0 PMT = 0 FV = FV = P/Y = 1 P/Y = 6 C /Y = 1 C /Y = 6 Now take the cursor up to FV Now take the cursor up to FV and press ALPHA and ENTER, and press ALPHA and ENTER, FV=$8954.24 FV=$6744.50 Final Answer is $8954.24+$6744.50=$15,698.49
Dr. Antara Mukherjee Section 5.2, Compound Interest

Applications
Problem # 33, page 365 Present Value Determine the amount of money, to the nearest dollar, you must invest at 6% per year, compounded annually so that you will be a millionaire in 30 years.

Dr. Antara Mukherjee

Section 5.2, Compound Interest

Applications
Problem # 33, page 365 Present Value Determine the amount of money, to the nearest dollar, you must invest at 6% per year, compounded annually so that you will be a millionaire in 30 years. Hint: Use the TVM Solver to compute PV when we have the following information, N = 30 I% = 6 PV = PMT = 0 FV = 1000000 P/Y = 1 C /Y = 1 Final Answer is $174,110.13
Dr. Antara Mukherjee Section 5.2, Compound Interest

Applications

Problem #42, page 365 Constant Dollars Ination is running 1% per month, you deposit $10,000 in an account earning 8% compounded monthly. In constant dollars, how much money will you have 2 years from now?

Dr. Antara Mukherjee

Section 5.2, Compound Interest

Applications

Problem #42, page 365 Constant Dollars Ination is running 1% per month, you deposit $10,000 in an account earning 8% compounded monthly. In constant dollars, how much money will you have 2 years from now? Hint: During Ination the best way to compare Future values or prices is to convert all prices and values to constant dollars. In other words nd FV rst and then convert this FV to constant dollars. Step 1: Find FV for the account using the TVM Solver. Step 2: Now use the Solver again this time with 1% per month ination rate and FV from the above step to compute the PV.

Dr. Antara Mukherjee

Section 5.2, Compound Interest

Applications

Problem #50, page 365 If an item in Mexico will cost 20,000 pesos in 10 years, what does it cost now? Note that the ination rate in Mexico is given as 5%.(Give your answer to the nearest peso).

Dr. Antara Mukherjee

Section 5.2, Compound Interest

Applications

Problem #56, page 366 Calculate to the nearest 0.01% your annual percentage return (assuming annual compounding), if you had bought Apple stock in February and sold in June.

Dr. Antara Mukherjee

Section 5.2, Compound Interest

Applications

Problem #57, page 366 Suppose you bought some Apple stock in January 2008. If you later sold at one of the marked dates on the chart, which of those dates would have given you the largest annual return (assuming annual compounding), and what would that return have been?

Dr. Antara Mukherjee

Section 5.2, Compound Interest