1. MBF3C Lesson #3: Compound Interest
PERSONAL FINANCE
MBF3C
Lesson #3: Compound Interest

2. Some notes about simple vs. compound Interest
Simple interest is a linear relation. Interest is only earned on the original principle.
Compound interest is exponential. Interest is earned not only on the original principle but also on the interest which has been earned so far.
 The difference between simple and compound interest is very small over a short period of time. However, unlike simple interest, if you earn compound interest, the amount of interest continues to increase over time. Over a long period of time, the interest earned in compound interest is much larger than the interest earned with simple interest.

3. (ignoring leap years, which have 366 days)
The time interval between the occasions at which interest is added to the account is called the compounding period . The chart below describes some of the common compounding periods:
Compounding Period
Descriptive Adverb
Fraction of one year
# of times
1 day
daily
1/365
(ignoring leap years, which have 366 days)
365
1 month
monthly
1/12 12
3 months
quarterly
1/4 4
6 months
semiannually
1/2 2
1 year
annually 1

4. Rather than using a table or a graph to see how the value of an investment grows, you can use a formula.

5. P is the principal, or initial value.
A is the accumulated amount or future value.
i is the interest rate per compounding period.
n is the number of compounding periods.

6. Number of compound periods per year
The table shows how to convert the yearly interest rate and term for various compounding periods. *continued on next slide
% per year compounded
Number of compound periods per year
Value for i
Value for n
Annually 1
𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑟𝑎𝑡𝑒 1
# 𝑜𝑓 𝑦𝑒𝑎𝑟𝑠 ×1
Semi-annually 2
𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑟𝑎𝑡𝑒 2
# 𝑜𝑓 𝑦𝑒𝑎𝑟𝑠 ×2
Every six months
Quarterly 4
𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑟𝑎𝑡𝑒 4
# 𝑜𝑓 𝑦𝑒𝑎𝑟𝑠 ×4
Every three months
Monthly 12
𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑟𝑎𝑡𝑒 12
# 𝑜𝑓 𝑦𝑒𝑎𝑟𝑠 ×12
Weekly 52
𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑟𝑎𝑡𝑒 52
# 𝑜𝑓 𝑦𝑒𝑎𝑟𝑠 ×52
Daily
365
𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑟𝑎𝑡𝑒 365
# 𝑜𝑓 𝑦𝑒𝑎𝑟𝑠 ×365

7. WHAT EXACTLY DOES THE “i” MEAN?
Annually
Once a year
Semi-annually
2 timesa year
Quarterly
4 times a year
Monthly
12 times a year
Bi-weekly
26 times a year
Weekly
52 times a year
Daily
365 times a year
Interest rate as a decimal
number of times per year that interest in compounded

8. WHAT EXACTLY DOES THE “n” MEAN?
Annually
Once a year
Semi-annually
2 timesa year
Quarterly
4 times a year
Monthly
12 times a year
Bi-weekly
26 times a year
Weekly
52 times a year
Daily
365 times a year
Number of times per year that interest is compounded per year x
Number of Years

9. Example: Interest Compounded Semi-Annually
Determine how much money you will have if $500 is invested for six years, at 4% per year, compounded semi-annually.
Solution
Interest is compounded semi-annually, meaning twice a year, for six years. There are 2 × 6, or 12, compounding periods. This can be illustrated on a timeline.

10. Determine how much money you will have if $500 is invested for six years, at 4% per year, compounded semi-annually.
i = 0.04 ÷ 2
= 0.02
n = 6 × 2
= 12
P = 500
A= 500(1+0.02)12
= After six years, you will have $

11. Example: Interest Compounded Monthly
Alice borrowed $5000 to start a small business. The interest rate on the loan was 9% per year, compounded monthly. She is expected to repay the loan in full after four years.
a) How much must Alice repay?
b) How much of the amount Alice repays will be interest?

12. A) How much must Alice repay?
Alice borrowed $5000 to start a small business. The interest rate on the loan was 9% per year, compounded monthly. She is expected to repay the loan in full after four years.
Interest is compounded monthly, meaning 12 times a year, for four years. There are 12 × 4, or 48, compounding periods.

13. Alice borrowed $5000 to start a small business
Alice borrowed $5000 to start a small business. The interest rate on the loan was 9% per year, compounded monthly. She is expected to repay the loan in full after four years.
i = 0.09 ÷ 12 =
n = 4 × 12
= 48
P = 5000
A= 5000( )48
= Alice must repay $ after four years

14. B) How much of the amount Alice repays will be interest?
Calculate the total interest by subtracting the principal from the amount. =
Therefore, Alice will pay $ in interest.

15. Key Concepts (p. 432)
Compound interest can be accumulated at various intervals, such as annually, semi-annually, quarterly, and monthly.
The compound interest formula A = P(1 + i)n can be used to calculate the future value, or amount
– A is the future value or accumulated amount of an investment or loan.
– P is the principal.
– i is the interest rate, in decimal form, per interest period.
– n is the number of compounding periods.

16. IN-CLASS & HOMEWORK
Page 432, # 1ace, 2bc, 3bd, 4, 5, 7, 8abcd

17. SUCCESS CRITERIA FOR THIS LESSON:
I can
____ Calculate the number of compound periods (n) and periodic interest rate (i)
____ Calculate the future amount or value of an investment using compound interest compounded over different periods
____ Calculate the interest earned on an investment