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04 Module 03 - Discrete Compounding Additional

The document explains discrete compounding with a nominal rate of 24% compounded quarterly, resulting in an effective rate of 26.25% per year. It discusses how to find equivalent monthly interest rates when payments are made monthly and how to adjust for different compounding frequencies. The formulas provided help calculate interest rates based on the compounding periods and payment schedules.

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treasurerrwin
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22 views7 pages

04 Module 03 - Discrete Compounding Additional

The document explains discrete compounding with a nominal rate of 24% compounded quarterly, resulting in an effective rate of 26.25% per year. It discusses how to find equivalent monthly interest rates when payments are made monthly and how to adjust for different compounding frequencies. The formulas provided help calculate interest rates based on the compounding periods and payment schedules.

Uploaded by

treasurerrwin
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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DISCRETE

COMPOUNDING
UNIVERSITY OF SAN CARLOS
ES ECON – ENGINEERING ECONOMICS
Clearer
Definition
• Assuming a nominal rate of 24%, compounded QUARTERLY.
• What does this mean?

It means, your money will compound EVERY Quarter of the


Year.

Sample
If the nominal rate is 24%, Divide it by 4 quarters in 1 Year.

It means, every QUARTER, it will compound at an interest of


6% (24%/4).
So, its effective interest is 6% per Quarter or in a year in
compounds quarterly.

ER = (1+.24/4)^4 = 26.25% (Per Year effective Rate)


• If the money is compounded quarterly and you are
paying monthly? What should you do?

• Both Quarterly compounding and Monthly


What compounding should have the same Effective rate of
interest. Right?
happens • So, since you know that the money is compounded
Quarterly with 6% per quarter.
? • What should be it’s equivalent monthly interest rate?
• [((1+ im)^3)-1 = ((1+iq)^1)-1] Eq 01.
• Eq. 1 tells you that monthly ER compounded 3 times is
equivalent to quarterly rate compounded 1 times.
• [((1+ im)^3)-1 = ((1+iq)^1)-1] Eq 01.

What
• So, since you know that ER Quarterly is 6%
• [((1+im)^3)-1 = ((1+6%)^1)-1]
happens • Im = 1.96%

?
• This is discrete compounding.
• I = ((1+r/M)^c)-1]
• This is discrete compounding.
• I = ((1+r/M)^c)-1]
• R = nominal rate
• Compounding periods
What • C – interest period per PAYMENT PERIOD

happens
• So if 24%, compounded quarterly and you are
paying monthly.

? • I = ((1+r/M)^c)-1]
• I = (1+24%/4)^(1/3))-1

Since in 1 Quarter it has


Quarterly
compounded 3 months,
rate That Exp. 1/3
• What if, it compounds monthly and payment is per
quarter??????
• NR = 24%, Compounded Monthly, Payment Quarterly.
• I = ((1+r/M)^c)-1]
• R = nominal rate
What • Compounding periods
• C – interest period per PAYMENT PERIOD
happens • So if 24%, compounded monthly and you are paying
quarterly.
? • I = ((1+r/M)^c)-1]
• I = (1+24%/12)^(3))-1
In other terms, it should have the same ER as a
monthly rate.
It means, Monthly Since in 1 Quarter has 3
(1+2%)^3 – 1 = 6.12% (Quarterly Rate ER) rate months, Exponent is 3.

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