SUBJECT: MATHEMATICS OF INVESTMENT

LESSON: COMPOUND MORE THAN ONCE A YEAR

LEARNING OUTCOME(S): At the end of the lesson, the learner is able compute maturity value, interest,
and present value, and solve problems involving compound interest when compound interest is computed
more than once a year
LESSON OUTLINE:
1. Compounding more than once a year
2. Maturity value, interest, and present value when compound interest is computed more than once
a year

Sometimes, interest may be compounded more than once a year. Consider the following example:

EXAMPLE 1: Given a principal of P10, 000, which of the following options will yield greater interest after
5 years?
OPTION A: Earn an annual interest rate of 2% at the end of the year, or
OPTION B: Earn an annual interest rate of 2% in two portions – 1% after 6 months, and 1% after
another 6 months?

SOLUTION:
OPTION A: Interest is compounded annually
Principal = P10,000
Time (t) in Annual Interest rate = 2%,compounded annually
years Amount at the end of the year
1 10,000 x 1.02 = 10,200
2 10,200 x 1.02 = 10,404
3 10,404 x 1.02 = 10,612.08
4 10,612.08 x 1.02 = 10,824.32
5 10,824.32 x 1.02 = 11,040.81

OPTION B: Interest is compounded semi-annually, or every 6 months

Under this option, the interest rate every 6 months is 1% (2% divided by 2).

Principal = P10,000
Time (t) in Annual Interest rate = 2%,compounded semi-annually
years Amount at the end of the year
1 10,000 x 1.01 = 10,100
2
1 10,100 x 1.01 = 10,201
1 10,201 x 1.01 = 10,303.01
1
2
2 10,303.01 x 1.01 = 10,406.04
1 10,406.04 x 1.01 = 10,510.10
2
2
3 10,510.10 x 1.01 = 10,615.20
1 10,615.20 x 1.01 = 10,721.35
3
2
4 10,721.35 x 1.01 = 10,828.56
1 10,828.56 x 1.01 = 10,936.85
4
2
5 10,936.85 x 1.01= 11,046.22
ANSWER: OPTION B will give the higher interest after 5 years. If all else is equal, a more frequent
compounding will result in a higher interest, which is why OPTION B gives a higher interest than
OPTION A.

The investment scheme in Option B introduces new concepts because interest is compounded twice a year,
the conversion period is 6 months, and the frequency of conversion is 2. As the investment runs for 5
years, the total number of conversion periods is 10. The nominal rate is 2% and the rate of interest for
each conversion period is 1%. These terms are defined generally below.

DEFINITION OF TERMS

FREQUENCY OF CONVERSION (m) – number of conversion periods in one year

CONVERSION or INTEREST PERIOD – time between successive conversions of interest
TOTAL NUMBER OF CONVERSION PERIODS n (n = mt = (frequency of conversion) x (time in
years)
NOMINAL RATE (i m) – annual rate of interest
i m annual rate of interest
RATE ( j) OF INTEREST FOR EACH CONVERSION PERIOD - j= =
m frequency of conversion

Note on rate notation: r, i m, j

In earlier lesson, r was used to denote the interest rate. Now that an interest rate can refer to two rates
(either nominal or rate per conversion period), the symbols i m and j will be used instead.

Examples of nominal rates and the corresponding frequencies of conversion and interest rate for each
period.
i m=Nominal Rate m = Frequency j = Interest rate per conversion One conversion
(Annual Interest Rate) of Conversion period period
2% compounded annually: 1 0.02 1 year
1 =0.02=2 %
i =0.02 1
2% compounded semi-annually: 2 0.02 6 months
2 =0.01=1 %
i =0.02 2
2% compounded quarterly: 4 0.02 3 months
4 =0.005=0.5 %
i =0.02 4
2% compounded monthly: 12 0.02 1 month
12 =0.0016=0.16 %
i =0.02 12
2% compounded daily: 365 0.02 1 day
365
i =0.02 365

From compound interest lesson, the formula for the maturity value F when principal P is invested at an
annual interest rate j compounded annually is F = P (1+ j)t .

im
Because the rate for each conversion period is j = , then in t years, interest is compounded nth times. The
m
following formula is obtained.
 MATURITY VALUE, COMPOUNDING m TIMES A YEAR
im mt
F=P(1+ )
m
F -maturity (future) value
where P - principal

i m – nominal rate of interest (annual rate)

t - term or time in years
m – frequency of conversion

EXAMPLE 2: Find the maturity value and the interest if P10,000 is deposited in a bank at 2% compounded
quarterly for 5 years.

Given : P = 10,000 i 4 = 2% = 0.02 t = 5 years m=4

Find: (a) F
(b) P

Solution:

Compute for the interest rate in a conversion period by

i 4 0.02 =0.005
j= =
m 4
Compute for the total number of conversion periods given by
n = mt = 4(5) = 20 conversion periods
Compute for the maturity value using
F=P(1+ j)n
= (10,000)(1+0.005)20
F = 11,048.96
The compound interest is given by
I c =F−P = 11,048.96 – 10,000 = 1,048.96

PRESENT VALUE P AT COMPOUND INTEREST

F
P= mt
i F
(1+ ¿ ¿ m) ∨P= ¿
m (1+ j)n
F -maturity (future) value
where P - principal

i m – nominal rate of interest (annual rate)

t - term or time in years
m – frequency of conversion
EXAMPLE 3: Find the present value of P50,000 due in 4 years if money is invested at 12% compounded
semi-annually.

Given : F = 50,000 i 2 = 0.12 t=4

Find: Present value P

Solution: First, compute for the interest rate per conversion period given by
2
i 0.02 =0.0 6
j= =
m 2
The total number of conversion periods is n = 4(2) = 8
The present value can be computed by substituting these values in the formula
F
P=
( 1+ j)n
Thus,
50,000 50,000
P= = =31 , 370.62
(1+ 0.06) (1.06)8
8

EXAMPLE 4: What is the present value of P25,000 due in 2 years and 6 months if money is worth 10%
compounded quarterly?

1
Given : F = 25,000 i 4 = 0.12 t=2
2

Find: Present value P

Solution: The interest rate per conversion period given by

i 4 0.10 =0.0 25
j= =
m 4

And the total number of conversion periods is

1
n = mt = 4 (2 ¿ = 10
2

The present value can be computed by substituting these values in the formula
F
P=
( 1+ j)n
Thus,
25 , 000 25 , 000
P= 10
= =19 , 529.96
(1+ 0.025) (1. 025)10
 SUPPLEMENTARY EXERCISES

DIRECTION: Use bond paper for your computations. If you’re done, submit your exercises to my email
[email protected] or directly to my messenger.

A. Complete the table by computing the interest rate per period and total number of conversion periods.
(2 Points each)

Nominal Rate Interest Frequency of Interest rate

im Compounded conversion for each
(m) conversion
period
10% Semi-annually (1) (2)
(3) Quarterly (4) 0.015
12% Monthly (5)

B. Complete the table by computing the maturity values, compound interests and present values.
(2 Points each)
Present Nominal Interest Interest Time in Total Compound Maturity
Value Rate Compounded rate per Years Number of Interest Value
m
i period conversion
s
20,000 6% Semi-annually (6) 8 (7) (8) (9)

(10) 10% Quarterly 2.5% 6 (11) 100,000

C. Solve for the following problems on compound interest. (2 Points each)

Jaime wishes to accumulate 1 million pesos in 12 years. Which investment will require the
smallest present value?

12. 8% simple interest

13. 8% compounded annually
14. 8% compounded semi-annually
15. 8% compounded quarterly
16. 8% compounded monthly

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