Compounding effect: Difference between revisions
imported>Doug Williamson m (Category added 9/10/13 and spacing) |
imported>Doug Williamson m (Added more space so that calculations are clearer) |
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The additional growth or additional interest, resulting from the compounding effects of - for example - interest on interest. | The additional growth or additional interest, resulting from the compounding effects of - for example - interest on interest. | ||
For example, interest quoted at 6% per annum, compounded annually, for two years maturity, means that the interest accumulated after two years is: | For example, interest quoted at 6% per annum, compounded annually, for two years maturity, means that the interest accumulated after two years is: | ||
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= 12.36% for the two year period. | = 12.36% for the two year period. | ||
Without the additional interest on interest, the total interest would have been simply 6% per annum x 2 years = 12.00%. | |||
So the compounding effect of interest on interest here = 12.36% - 12.00% = 0.36% over the two year period (= 6% x 6%). | Without the additional interest on interest, the total interest would have been simply | ||
6% per annum x 2 years | |||
= 12.00%. | |||
So the compounding effect of interest on interest here | |||
= 12.36% - 12.00% | |||
= 0.36% over the two year period (= 6% x 6%). | |||
When both the number of periods and the rate of growth/interest are low, compounding effects are relatively small. | When both the number of periods and the rate of growth/interest are low, compounding effects are relatively small. | ||
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* [[Continuously compounded rate of return]] | * [[Continuously compounded rate of return]] | ||
[[Category: | [[Category:Manage_risks]] | ||
Revision as of 14:06, 20 September 2014
The additional growth or additional interest, resulting from the compounding effects of - for example - interest on interest.
For example, interest quoted at 6% per annum, compounded annually, for two years maturity, means that the interest accumulated after two years is:
= [1.06 x 1.06] - 1
= 12.36% for the two year period.
Without the additional interest on interest, the total interest would have been simply
6% per annum x 2 years
= 12.00%.
So the compounding effect of interest on interest here
= 12.36% - 12.00%
= 0.36% over the two year period (= 6% x 6%).
When both the number of periods and the rate of growth/interest are low, compounding effects are relatively small.
When either the number of periods or the rate of growth/interest - or both - are greater, compounding effects become very much larger.
