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calculate the solution for time value of money problems with different frequencies of compounding
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In this section, we examine investments paying interest more than once a year. For instance, many banks Category
offer a monthly interest rate that compounds 12 times a year. In such an arrangement, they pay interest on
Interest Rates, Present Value,
interest every month. Rather than quote the periodic monthly interest rate, financial institutions often quote and Future Value
an annual interest rate that we refer to as the stated annual interest rate or quoted interest rate. We
denote the stated annual interest rate by rs. For instance, your bank might state that a particular CD pays 8 r Related Questions:

percent compounded monthly. The stated annual interest rate equals the monthly interest rate multiplied by Practice questions related to
this topic
12. In this example, the monthly interest rate is 0.08/12 = 0.0067 or 0.67 percent.5 This rate is strictly a
quoting convention because (1 + 0.0067)12 = 1.083, not 1.08; the term (1 + rs) is not meant to be a future
value factor when compounding is more frequent than annual.

With more than one compounding period per year, the future value formula can be expressed as
rs mN
FV N = PV(1 + ) 3
m
where rs is the stated annual interest rate, m is the number of compounding periods per year, and N now
stands for the number of years. Note the compatibility here between the interest rate used, rs/m, and the
number of compounding periods, mN. The periodic rate, rs/m, is the stated annual interest rate divided by
the number of compounding periods per year. The number of compounding periods, mN, is the number of
compounding periods in one year multiplied by the number of years. The periodic rate, rs/m, and the number
of compounding periods, mN, must be compatible.

EXAMPLE 4

The Future Value of a Lump Sum with Quarterly Compounding

Continuing with the CD example, suppose your bank offers you a CD with a two-year maturity, a stated
annual interest rate of 8 percent compounded quarterly, and a feature allowing reinvestment of the
interest at the same interest rate. You decide to invest $10,000. What will the CD be worth at maturity?

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Solution:

Compute the future value with Equation 3 as follows:

PV = $10,000
rs = 8% = 0.08
m=4
rs /m = 0.08/4 = 0.02
N=2
mN = 4 (2) = 8 interest periods
rs mN
FV N = PV(1 + )
m
= $10,000(1.02)8
= $10,000 (1.171659)
= $11,716.59

At maturity, the CD will be worth $11,716.59.

The future value formula in Equation 3 does not differ from the one in Equation 2. Simply keep in mind that
the interest rate to use is the rate per period and the exponent is the number of interest, or compounding,
periods.

EXAMPLE 5

The Future Value of a Lump Sum with Monthly Compounding

An Australian bank offers to pay you 6 percent compounded monthly. You decide to invest AUD 1
million for one year. What is the future value of your investment if interest payments are reinvested at 6
percent?

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Solution:

Use Equation 3 to find the future value of the one-year investment as follows:

PV = A$1,000,000
rs = 6% = 0.06
m = 12
rs /m = 0.06/12 = 0.0050
N=1
mN = 12 (1) = 12 interest periods
rs mN
FV N = PV(1 + )
m
= A$1,000,000(1.005)12
= A$1,000,000 (1.061678)
= A$1,061,677.81

If you had been paid 6 percent with annual compounding, the future amount would be only AUD
1,000,000(1.06) = AUD 1,060,000 instead of AUD 1,061,677.81 with monthly compounding.

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Discussion

"the stated annual interest rate equals the monthly interest rate multiplied by 12. In this example, the monthly interest rate is 0.08/12 = 0.0067 or 0.67 percent". asking for
SS
multiplication but dividing in example is this an error please provide clarity.

Created a month ago by Shiv Sharma 3 replies | Last Activity: 3 days ago
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NG The wording is confussing, but my understanding is that, as the stated annual interest rate equals the monthly interest multiplied by 12,
then the monthly interst rate is the stated annual interest rate divided by 12, since multiplication and division are opposite operations.
Nazaret Gallego Menendez replied 20 days ago

NC Hi Shiv Sharma,
Hope my answer finds you well.
The calculation would be as below
If you are having monthly compounding on a question that would mean you divide your interest rate by 12 month, So here it is 0.08
(8%/100) = 0.08/12 = 0.67%
Similarly if it was quartlery than 0.08/4
Nitish Chaulkar replied 12 days ago

AR we have to multiply 12 with the number of years in power, but in order to get the monthly for an year we have to divide it with the number
of compounding months
Aviral Rathi replied 3 days ago

I feel confident breaking down the equation and I am getting accurate results.
AM

I see everyone making suggestions and giving examples on how to use the time value of money functions on the calculator. I was only using the calculator to do the basic math
to get to my final answer which was working great. Once I tried to use the time value functions and plug in all of my variables, I began to get very confused.

I mix up the C/Y and P/Y and find it easier to calculate mN and do the math from there.

My ultimate question: Will I be fine manually putting all of this in and not going out of my way to figure out how to use the time value of money functions? I don't want to risk
skipping on necessary knowledge but if learning C/Y and P/Y is not necessary and a "manual way" is just as effective I'd like to stick to it.

Created 6 days ago by Amy Moreno 1 reply | Last Activity: 5 days ago
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EE
You would need to understand how to use the calculator because the exam is timed and most TVM questions can be quick to answer
once you understand how to input them on the calculator.

To understand C/Y and P/Y

C/Y : is the number of interest compounding in a year, so if the question says compounding monthly the c/y is 12
P/Y : is the number of payments periods per year, so if it is compounding monthly but there is no payment period meaning it is reinvested,
the C/Y is 12 and your P/Y is 1. Now you can input the other figures in the question without having to multiple or divide them as necessary
if you were doing it manually.
Ebunoluwa Elizabeth Ahove replied 5 days ago

Done
CM

Created 11 days ago by Carlos Morais 0 replies | Last Activity: 11 days ago
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Does anyone know how to do this on the financial calculator. I am changing the monthly compounding to 4 in example 4 for example using the following:
FW

1: Turn on calculator (BA11 Plus). 2nd key, then I/Y (when 2nd key is P/Y). Then hit 4 and then enter.
2. 2=N, 8=I/Y, 10,000=PV
3. FV=CPT

I am not getting the same answer?

Created 6 months ago by Finnian William Thornton 5 replies | Last Activity: a month ago
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KN
So because this is compounded quarterly, your N would be 8 (4 quarters/year x 2 years). Your I/Y would be 2 (8 Interest rate divided by 4
quarters).
*Note: For the sake of using the calculator its important you do not input the interest rate as 8% or 0.08 as this would throw off your I/Y
number*

Pluggin in everything:

N=8
I/Y = 2
PV = 10,000
PMT = 0
CPT , FV = 11,716.59

Hope this helped!

Kendrick Nguyen replied 6 months ago

NM Another way to use the calculator, would be to input P/Y as 1, C/Y as 4 (for 4 quarters). You can access C/Y by hitting "2nd", then P/Y then
arrow down.

N=2 years
I/Y = 8
P/Y = 1
C/Y = 4
PV = 10,000
PMT = 0

I found this useful youtube video https://shorturl.at/opR67 had to shorten the link as it doesn't allow youtube links here

Nicolette Monique Cross replied 3 months ago

SS @Kendrick Nguyen i entered the same values on ba2+ pro calculator but i am getting 11730.43

Shiv Sharma replied a month ago

SS @Nicolette Monique can you please share the link on whatsapp by any chance

Shiv Sharma replied a month ago

RB Set the Number of Payments per Year: First, we need to set the calculator for monthly compounding.
Press 2nd then P/Y.
Enter 12 and press ENTER, then press 2nd and QUIT to confirm monthly compounding.
Input the Number of Periods (N): Since the investment is for one year and interest is compounded monthly, there will be 12 compounding
periods.
Enter 12 and press N.
Input the Interest Rate (I/Y): The annual interest rate is 6%, but because it’s compounded monthly, we input the annual rate directly.
Enter 6 and press I/Y.
Enter the Present Value (PV): The initial investment is AUD 1 million.
Enter 1000000 and press PV.
Set the Payment (PMT): Since there are no additional payments, set this to zero.
Enter 0 and press PMT.
Compute Future Value (FV):
Press CPT and then FV to compute the future value. Your answer will be A$1,061,677.81
Rushit Bharatkumar Patel replied a month ago

Does anyone know if on the exam we will need to utilize the formula and / or show the work, instead of using the calculator shortcut?
ML

Created 2 months ago by Megan Lisenbee 1 reply | Last Activity: a month ago
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WA
On exam, you just need to select your answer. Doesnt matter if you use calculator or the formula

Walter Alejandro Serrano replied a month ago

Ex4. Use the texas calculator. Enter in order: 8,N,2,I/Y,-10000,PV,0,PMT,CPT,FV.

WC

Created 2 months ago by Wenjing Chen 0 replies | Last Activity: 2 months ago
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How does one compute example 5 on the BA 2 PLUS calculator?

MK

Created 3 months ago by Motlatsi Kgaphola 1 reply | Last Activity: 3 months ago
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VS Example 5:
An Australian bank offers to pay you 6 percent compounded monthly. You decide to invest AUD 1 million for one year. What is the future
value of your investment if interest payments are reinvested at 6 percent?

for the financial calculator, you need to understand what the following buttons mean for TVM:

N - number of periods (number of compounding periods per year * number of years)

I/Y - compounding interest rate (matching with the frequency of compounding per year) - insert as a %

for this question:

6% compounded monthly means that you'd have to get the monthly compounded rate first : 6%/12 = 0.5%
1 year means you will have 12 periods in total

therefore, you would enter 0.5 as your I/Y and 12 as your N

put -1,000,000 as PV and set 0 as PMT (should be default as 0) and compute FV

Vikrant Shridhar Sharma replied 3 months ago

Can some one please explain the second part of last example please reinvested at 6% ?
VD

Created 5 months ago by Vibhav Dixit 1 reply | Last Activity: 5 months ago
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SR
Hi Vibhav, I think re-invested at 6% means the payment you receive from the bank every month is added to the principal amount for which
the compound interest is calculated on a monthly basis. if the money is not reinvested then the bank would be calculating compound
interest for 1 million on the first month, the second month, the third month and so on. If it is reinvested then on the second month the
interest is calculated for 1 million + interest from first month.
Hope i was able to help you understand this example problem
Seetharam Ramachandran replied 5 months ago

This section isn't making sense to me and the why it is explained is not clear. Can we have another explination as to why N all of a sudden becomes M and why? Why must they
AA
be the same or "compatible" as they they say. I have the section that doesnt make sense as follows: "Note the compatibility here between the interest rate used, rs/m, and the
number of compounding periods, mN. The periodic rate, rs/m, is the stated annual interest rate divided by the number of compounding periods per year. The number of
compounding periods, mN, is the number of compounding periods in one year multiplied by the number of years. The periodic rate, rs/m, and the number of compounding
periods, mN, must be compatible." Why must they be compatible and how do we know when this should happen?

Created 6 months ago by Anne Adiele 1 reply | Last Activity: 6 months ago
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MJ
The formula is just the same as the previous page. The only difference is you have to compound the periods and unannualized the interest
rate. In the example #4 above - The Future Value of a Lump Sum with Quarterly Compounding. You can just simplify the given and use the
previous page formula:

PV= $10,000
N= 8 (4x2 or quarterly for 2 years)
R= 2% (8% divided by 4 --> unannualized as payment is made quarterly)
FV= $10,000 (1.02)^8
FV= $10,000 (1.171659381)
FV= $11,716.59
Marion Jade Mendoza Limonero replied 6 months ago

In example 5, the statement "An Australian bank offers to pay you 6 percent compounded monthly" can be taken as a period rate of 6% every month. What is the best way to
AS
determine if they are providing a stated annual interest rate or a period rate when looking at this statement?

Created 9 months ago by Althea Scott 5 replies | Last Activity: 7 months ago
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CC
In almost all problems it will be the yearly interest rate. It would be clearly stated if it was 6% monthly because that's a ridiculously high
rate for anything in real life.
Cooper Carter replied 9 months ago

TJ
The "stated annual interest rate" is always the one that will be detailed in those particular statements. It's up to us to find the specific
period rate which in this case being 0.005. As shown in the example.
Thonoak Jacob Archvarin replied 9 months ago

TO
you need to use logic here, 6 percent compounded monthly means the investor would more than double their initial investment in 12
months, which does not sound right
Taylan Olmez replied 8 months ago

HM
thanks for asking this made me notice this aspect

Hunny Meghani replied 7 months ago

PA
all rates that you see are quoted annually, no matter where you see them, no matter what period time its for. E.g. if you see a 3-months
rate somewhere and it´s 1%, that percentage do NOT mean 1% for 3 months. It is an annual rate, i.e 1% stated as an annual rate BUT
you only get that return over a 3-month period, hence in reality you only get a 0.25% over those 3 months.

But remember: ALL RATES are quoted annually.

Pierre Andersson replied 7 months ago

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