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    Introduction To Compounding

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    manjulabk.24dvg

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    Introduction To Compounding

    Uploaded by

    manjulabk.24dvg
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    Introduction-to-Compounding ppt

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    6 views8 pages

    Introduction To Compounding

    Uploaded by

    manjulabk.24dvg

    Copyright:

    © All Rights Reserved
    Download as PPTX, PDF, TXT or read online from Scribd
    Download as pptx, pdf, or txt
    of 8

    Introduction to

    Compounding
    Compounding is a powerful technique for growing wealth over
    time. It involves earning interest on both the initial investment
    and accumulated interest. This creates a snowball effect, where
    your money grows exponentially.

    by Manjula B K
    Time Value of Money Concepts
    The time value of money concept acknowledges that money today is worth more than the same amount of money in
    the future due to its potential earning capacity. Compounding is a key principle in understanding this concept.

    Inflation Opportunity Cost Risk and Return


    Inflation erodes the purchasing Money held idle has the Higher risk investments
    power of money over time. potential to earn returns, but it generally offer the potential for
    Compounding can help counter also incurs an opportunity cost. higher returns, which can be
    this effect. amplified by compounding.
    Simple Interest vs. Compound Interest
    Simple interest is calculated only on the principal amount, while compound interest is calculated on both the
    principal and accrued interest. This difference leads to significant growth disparities over time.

    Simple Interest Compound Interest

    Interest is calculated only on the principal amount. Interest is calculated on both the principal and
    It's a linear growth. accrued interest, leading to exponential growth.

    1. Fixed Interest Rate 1. Variable Interest Rate


    2. Principal remains unchanged 2. Principal increases with each period
    Compounding Frequency and Its Impact
    The frequency of compounding determines how often interest is calculated and added to the principal. Higher compounding
    frequencies result in faster growth.

    1 Annual Compounding
    Interest is added once a year.

    2 Semi-Annual Compounding
    Interest is added twice a year.

    3 Quarterly Compounding
    Interest is added four times a year.

    4 Monthly Compounding
    Interest is added twelve times a year.

    5 Continuous Compounding
    Interest is added infinitely many times a year.
    Calculating Future
    Value with
    Compounding
    The future value (FV) represents the value of an investment at a
    future point in time. It is calculated using the principal amount,
    interest rate, compounding frequency, and time period.

    FV = PV * (1 + r/n)^(nt)

    FV = Future Value

    PV = Present Value

    r = Interest Rate

    n = Number of Compounding Periods per Year

    t = Time in Years
    Calculating Present
    Value with
    Compounding
    The present value (PV) represents the value of a future
    investment in today's terms. It is calculated using the future
    value, interest rate, compounding frequency, and time period.

    PV = FV / (1 + r/n)^(nt)

    PV = Present Value

    FV = Future Value

    r = Interest Rate

    n = Number of Compounding Periods per Year

    t = Time in Years
    Solving Simple
    Compound Interest
    Problems
    Compound interest problems can be solved using formulas or
    financial calculators. Understanding the basic concepts and
    formulas allows you to calculate future values, present values,
    and other relevant variables.

    1 Problem 1 2 Problem 2
    Calculate the future Calculate the present
    value of $10,000 value of $20,000 to be
    invested for 5 years at received in 10 years at
    5% annual interest, 8% interest,
    compounded annually. compounded semi-
    annually.
    Conclusion and Key Takeaways
    Compounding is a powerful tool for wealth accumulation, allowing you to earn
    interest on interest. Understanding the concepts of time value of money,
    compounding frequency, and formulas for calculating present and future values
    are essential for making informed financial decisions.

    Start Early
    The earlier you start compounding, the greater the potential for growth.

    Invest Regularly
    Regular investments contribute to compounding and accelerate
    wealth accumulation.

    Seek Professional Advice


    Financial advisors can help you develop a plan tailored to your financial goals.

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