Week 7 Periods of Compounding Other Than A Year

Periods Of Compounding Other Than A Year

The frequency of compounding of the interest rate affects the value calculations. The result is not the same when interest is compounded quarterly, for example, as it is if interest is compounded annually.

Yearly compounding is usually assumed, but it is not always the case. Semiannual, quarterly, monthly, weekly, and even daily compounding periods are not uncommon.

For example, in the example presented earlier which called for calculating the Future Value of $100 invested for three years at 10% interest, if interest were compounded quarterly, you would have 3 x 4 = 12 periods instead of 3, and the stated rate of interest for each period would be 10% ÷ 4 = 2.5%. The problem would appear as follows:

Note that the FVIF table in the appendix at the back of the textbook is not so good here because it doesn't contain rates like 2.5%. That's why it's good to know the algebraic form of the equations.