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Compound Interest

This lesson explores the concept of compound interest, specifically the differences between nominal and effective rates, the compound interest formula, and the comparison between periodic and continuous compounding.

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Compound Interest

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  1. Compound Interest Lesson 3.5

  2. Agree or Disagree ? • A bank account that pays 12% per year yields the same results as a bank account that pays 1% every month and compounds interest.

  3. Nominal vs. Effective Rate • Nominal rate • The stated yearly rate • "12% compounded monthly" • Effective rate • The result of the compounding • 12% compounded monthly actually gives a 12.683% return on your investment

  4. Compound Interest Formula • Actually we saw this in the previous lesson • Here • r = the nominal rate • Then is the decimal for the effective rate

  5. Periodic vs. Continuous • Note the similarities between periodic compoundingand continuous compounding

  6. Periodic vs. Continuous • The k in the continuous model will always be similaror close to the r value in the periodic compounding model • Generally r must be slightly larger because there are "less" compounding periods per year • Example • Convert B = P e .05t to periodic • Convert 7.25% compounded monthly to continuous form

  7. Assignment • Lesson 3.5 • Page 139 • 1 – 21 odd

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