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Frequent Compounding of Interest Rates

Frequent Compounding of Interest Rates. Which rate is better if you’re a saver? 7.30% compounded quarterly 7.275% compounded monthly 7.25% compounded weekly Find equivalent annually compounded rate of interest and then compare. Interest Rate Conversion Key on Calculator.

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Frequent Compounding of Interest Rates

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  1. Frequent Compounding of Interest Rates • Which rate is better if you’re a saver? • 7.30% compounded quarterly • 7.275% compounded monthly • 7.25% compounded weekly • Find equivalent annually compounded rate of interest and then compare

  2. Interest Rate Conversion Key on Calculator • Second function of Number 2 on Calculator: ICONV • 3 Variables: • NOM = stated annual rate (nominal rate) • C/Y = compounding periods per year • EFF = effective annually compounded rate of interest (EAR)

  3. How does frequent compounding affect borrowers? • Say your credit card balance remains at $2,000 every month. (You make payments but new purchases and interest charges keep it at exactly $2,000 each month.) • Interest rate = 22.9% compounded monthly • How is monthly interest calculated? Annual interest? • Why is true cost to borrower greater than 22.9%?

  4. Loan Repayment and Frequent Compounding • Borrow $100,000 for 15 years. Repay in equal monthly payments (part principal, part interest). • Compare interest rate of 8% compounded annually to 8% compounded monthly. • Under which rate do you pay more interest?

  5. Conclusion • Savers love frequent compounding of interest • Borrowers don’t like it, but they don’t have any choice!

  6. Saving for Retirement • Deposit $400 monthly at the end of each month into a 401K. Deposits earn an average of 5%, compounded monthly. • How much is in the account after 45 years? • How much of that did you contribute yourself?

  7. Withdrawals upon retirement • Suppose you switch the account balance to a safer investment after 45 years (upon retirement) that pays only 3% interest, compounded monthly. • What equal amount could you withdraw, each month, from your account over a 20 year period to have a zero balance in the account after the last withdrawal?

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