1. Definitions for Savings Account 2. Common Compounding Periods 3. New from Previous Balance 4. Present and Future Value 5. Simple Interest 6. Effective Rate of Interest 7. Calculator Solutions 1

 Interest is the fee a bank pays for the use of money deposited into a savings account.  The amount deposited is called the principal.  The amount to which the principal grows (after the addition of interest) is called the compound amount or balance.  If interest is compounded m times per year and the annual interest rate is r, then the interest rate per period is i = r/m. 2

 For the passbook above, determine the principal, compound amount after 1 year, compound interest rate and annual interest rate. 3 DateDepositsWithdrawalsInterestBalance 1/1/05$ /1/05$1.00$ /1/ $ /1/ $ /1/ $104.06

 The principal is $  The compound amount after 1 year is $  The compound interest rate is 1% since the interest earned in the first period, $1.00, is 1% of the principal.  Interest is compounded 4 times per year so the annual interest rate is 4·1% = 4%. 4

5 Number of interest periods per year Length of each interest period Interest compounded 11 yearAnnually 26 monthsSemiannually 43 monthsQuarterly 121 monthMonthly 521 weekWeekly 3651 dayDaily

 For a savings account in which the interest rate per period is i, the interest earned during a period is i times the previous balance.  The new balance, B new is computed by adding the interest earned during the period to the previous balance, B previous.  B new = B previous + i · B previous  B new = (1 + i ) B previous 6

 Compute the interest and the balance for the first two interest periods for a deposit of $1000 at 4% compounded semiannually.  For semiannually m = 2 so i = (4/2)% = 2% =.02.  First period: interest =.02(1000) = $20  B 1 = = $1020  Second period: interest =.02(1020) = $20.40  B 2 = = $

 Let i be the interest per period, P the principal and F the balance after n periods, then  F is also referred to as the future value and P as the present value. 8

 If an account pays 6% compound quarterly,  a ) find the amount in the account after 5 years if $1000 is initially deposited;  b ) find the amount that must be initially deposited if $3000 is needed in 5 years. 9

 Period interest is i =.06/4 =.015.  Number of periods is n = 4*5 = 20.  a ) P = $1000 so F = 1000( ) 20 = $  b ) F = $3000 so 10

 Simple interest is earned only on the principal and is not compounded.  If r is the annual percentage rate and n is the number of years, then  Interest = nrP, and  F = P + nrP = (1 + nr ) P. 11

 Calculate the amount after 4 years if $1000 is invested at 5% simple interest.  F = (1 + 4(.05))1000 = $

 The effective rate of interest is the simple interest rate that yields the same amount after one year as the annual rate of interest.  If r is the annual interest rate compounded m times a year, then i = r / m and  r eff = (1 + i ) m – 1. 13

 Calculate the effective rate of interest for a savings account paying 3.65% compounded quarterly.  r eff = ( /4) =.037  So the effective rate is 3.7%. 14

 Use a calculator to determine when the balance in a savings account in which $100 is deposited at 4% compounded quarterly reaches $130.  For a TI-83 set  Y 1 = (1 +.04/4)^X*100 and  Y 2 = 130.  Find the intersection of the two graphs. 15

 The intersection is at X = , so in 27 quarters the balance will exceed $ Graph of Y 1 and Y 2 with intersection Table of Y 1

 Money deposited into a savings account earns interest at regular time periods. Interest paid on the initial deposit only is called simple interest. Interest paid on the current balance (that is, on the initial deposit and the accumulated interest) is called compound interest.  Successive balances of a savings account with compound interest can be calculated with B new = (1 + i ) B previous. 17

 P - principal, the initial amount of money deposited into a savings account. P also represents the present value of a sum of money to be received in the future; that is, the amount of money needed to generate the future money.  r - annual rate of interest, interest rate stated by the bank and used to calculate the interest rate per period. 18

 m - number of ( compound ) interest periods per year, most commonly 1, 4, or 12.  i - compound interest rate per period, calculated as r/m.  n - number of interest periods.  F - future value, compound amount, or balance, value in a savings account. F = (1 + i ) n P with compound interest, and F = (1 + nr ) P with simple interest. 19

 r eff - effective rate of interest, the simple interest rate that yields the same amount after one year as the annual rate of interest. r eff = (1 + i ) m – 1 20