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Understanding Compound Interest Concepts

This document covers Chapter 3 of MAT112 Business Mathematics, focusing on the concept of compound interest. It explains the differences between simple and compound interest, provides formulas for calculating future value and compound interest, and defines key terms related to interest calculations. Additionally, it includes examples to illustrate how to apply these concepts in real-world financial scenarios.

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50 views5 pages

Understanding Compound Interest Concepts

This document covers Chapter 3 of MAT112 Business Mathematics, focusing on the concept of compound interest. It explains the differences between simple and compound interest, provides formulas for calculating future value and compound interest, and defines key terms related to interest calculations. Additionally, it includes examples to illustrate how to apply these concepts in real-world financial scenarios.

Uploaded by

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

MAT112 Business Mathematics

CHAPTER 3

COMPOUND INTEREST

LEARNING OBJECTIVES

After completing this chapter, students should be able to:


 explain the concept and the important terms used in compound interest.
 use the compound interest formula to calculate the amount of interest, principal, future value, interest
rate and time.

INTRODUCTION

 It is calculate based on the principal which changes every year (because based on the latest
balance).
 The interest due is added to the principal at the end of each interest period and thereafter earns
interest.
 Principal increase from time to time.

SIMPLE INTEREST VERSUS COMPOUND INTEREST

Year Simple Interest Compound Interest


I  1,000  0.1  1  RM 100 I  1,000  0.1  1  RM 100
First Year
S  1,000  100  RM 1,100 S  1,000  100  RM 1,100
I  1,000  0.1  1  RM 100 I  1,100  0.1  1  RM 110
Second Year
S  1,000  100  100  RM 1,200 S  1,100  110  RM 1,210
I  1,000  0.1  1  RM 100 I  1,210  0.1  1  RM 121
Third Year
S  1,000  100  100  100  RM 1,300 S  1,210  121  RM 1,331

FORMULA

(a) Future Value / Accumulated Value / Sum, S


mt
 k
S  P1  i 
k
 S  P1   i and n  mt
n

 m m

(b) Compound Interest, I

I SP

NZS UiTMJ 1
MAT112 Business Mathematics

S  Future Value/Acc umulated Value/Sum /Total Amount/Ma turity Val ue (in RM)
P  Present Value/Dis counted Value/Pri ncipal (in RM)
I  Compound Interest (in RM)
i  Periodic Interest Rate (in %)
t  Term of Investment or Loan (in years)
n  Number of Payments (in months, weeks or days)

TERMS

(a) Original Principal, P (in RM)


 The original amount of investment or loan.

(b) Annual Nominal Rate, k (in %)


 The interest rate for a year together with the frequency in which the interest is calculated in a
year.
 The rate of interest is usually stated as an annual interest rate.
 Case: (i) Compounded Annually / Yearly
 It means interest is calculated once a year.
(ii) Compounded Semiannually / Half-yearly / Every 6 months
 It means interest is calculated two times/twice a year.
(iii) Compounded Quarterly / Every 3 Months
 It means interest is calculated four times a year.
(iv) Compounded Monthly
 It means interest is calculated every month.
(v) Compounded Weekly
 It means interest is calculated every week.
(vi) Compounded Daily
 It means interest is calculated everyday.
(vii) Compounded Every 2 Months
 It means interest is calculated every 2 month.
(viii) Compounded Every 4 Months
 It means interest is calculated every 4 month.
 Example: Arief invests RM10,000 for 10 years at 10% compounded semiannually.
k  10%  0.1
(c) Interest Period, t (in years)
 Length of time in which interest is calculated.
 Example: Arief invests RM10,000 for 10 years at 10% compounded semiannually.
t  10
(d) Frequency of Conversions, m
 The number of times interest calculated in a year.
 Case: (i) Compounded Annually / Yearly  m 1
(ii) Compounded Semiannually / Every 6 Months / Half-yearly  m2
(iii) Compounded Quarterly / Every 3 Months  m4
(iv) Compounded Monthly  m  12
(v) Compounded Weekly  m  52
(vi) Compounded Daily  m  360
(vii) Compounded Every 2 Months  m6
(viii) Compounded Every 4 Months  m3

NZS UiTMJ 2
MAT112 Business Mathematics

 Example: Arief invests RM10,000 for 10 years at 10% compounded semiannually.


m2
(e) Periodic Interest Rate, i (in %)
 The interest rate for each interest periods.
 Example: Arief invests RM10,000 for 10 years at 10% compounded semiannually.
k 10%
i   0.05  5%
m 2
(f) Number of payments, n
 Number of times interest is calculated.
 Example: Arief invests RM10,000 for 10 years at 10% compounded semiannually.
n  mt  2 10  20

NZS UiTMJ 3
MAT112 Business Mathematics

Example 1: Calculate the amount obtained for the following investments:


(a) RM1,300 with interest 9% compounded semiannually for 5 years.
(b) RM850 with interest 8% compounded quarterly for 3.5 years.
(c) RM2,500 with interest 6.5% compounded monthly for 8 months.

Solution:

(a)

P = 1300 k = 9% , m = 2 S=?

0 5
S  P1  i
n

25 
 0.09 
 1300 1 
 2 
 RM2018.86

(b)

P = 850 k = 8% , m = 4 S=?

0 3.5

(c)

P = 2500 k = 6.5% , m = 12 S=?

0 8 months

NZS UiTMJ 4
MAT112 Business Mathematics

Example 2: Bank D gives a loan of RM20,000 to Aiman with an interest rate of 9.25% compounded every
3 months. Aiman needs to settle the loan after 4 years 9 months.
(a) Find the amount that Aiman needs to pay to Bank D.
(b) Calculate the amount of interest charged.

Solution:

P = 20000 k = 9.25% , m = 4 S=?,I=?

0 4 years 9 months
(a)
S  P1  i
n

 57 

 4 
 0.0925  
 12 
 20000 1 
 4 
19
 0.0925 
 20000 1 
 4 
 RM30879.85

(b)
I  S-P
 30879.85 - 20000
 RM10879.85

NZS UiTMJ 5

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