The Mathematics of Money

86

Compound

Interest

“The most powerful force in the universe

is compound interest.”

—Quote often attributed to Albert Einstein

Learning Objectives

LO 1 Recognize the difference between simple and

compound interest, and understand the reasoning

behind compound interest.

LO 2 Find the future value or present value of a sum

of money invested at compound interest.

LO 3 Calculate compound interest using different

compounding frequencies.

LO 4 Evaluate the impact of compounding frequency

on the total amount of interest earned.

LO 5 Find and interpret the effective interest rate

for a given nominal rate and compounding

frequency.

LO 6 Apply the mathematical tools for compound

interest to other types of compound growth.

Chapter Outline

3.1 Compound Interest: The Basics

3.2 Compounding Frequencies

3.3 Effective Interest Rates

3.4 Comparing Effective and Nominal Rates

3.5 Solving for Rates and Times (Optional)

3.1 Compound Interest: The Basics

So far our discussion of interest (and discount) has dealt only with simple interest and

discount. Saying “simple interest” as opposed to just plain “interest” suggests that

there is some other kind. Though we have not yet used the term in this text, you have

nonetheless probably heard the term compound interest at some point or other. In this

chapter we will investigate compound interest and see how it differs from its simple

cousin.

CHAPTER

3