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Compound Interest Interest Interest Interest Interest Interest Interest Asst. Professor D. Urmston SUNY Orange Begin Learning Objectives Understand the concept of compound interest Calculate compound interest using a spreadsheet

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Interest

Interest

Interest

Interest

Interest

Interest

Interest

Asst. Professor D. Urmston

SUNY Orange

Begin

• Understand the concept of compound interest

• Calculate compound interest using a spreadsheet

• Compare the results of simple addition, simple interest and compound interest for a given situation

Continue

We want to see the difference compound interest can make when someone saves for the future. So imagine you are faced with a choice:

• Save your money in a jar (\$100/month for 20 years.)(Simple Addition)

• Put your money in the bank but then take it out at the end of each year and put it in the jar (\$100/month for 20 years).(Simple Interest)

• Put your savings into the bank as you earn it and earn compound interest (\$100/month for 20 years- leaving it in the bank).(Compound Interest)

We know that you will have more money under situation 3, but how much more?

Continue

How it works: You start with the tutorial and progress through the 3 types of savings. You must complete the work for each section before you can move on to the next section. You may skip the tutorial if you wish. You may return to the main menu at any time to repeat a section or to view the learning objectives

1

2

3

Simple Interest

4

5

Compound Interest

Quiz

Learning Objectives

If the Flash tutorials are not working, click here for the alternate video viewer

Copying Formulas

Directions: Click on the film reel on the left and a video viewer will open. (It may take a few minutes). Once the video viewer is open, choose File>>> Quick Open File>>> from the drop down menu choose the CD then open the folder Interest Project>>>Tutorials

Watch the tutorials in this order:

Basic_formulas

Copying1

Copying2

Click to play tutorial. A new window will open. When you are finished with the tutorial, close the window.

Tutorial

Click to play tutorial. A new window will open. When you are finished with the tutorial, close the window.

Tutorial

Click to play tutorial. A new window will open. When you are finished with the tutorial, close the window.

Tutorial

Copying Formulas

Click to play tutorial. A new window will open. When you are finished with the tutorial, close the window.

Tutorial

Welcome to the first step in your journey. All you have to do to move on is to answer the question on the following page. Oh, there is one catch…in order to answer the question, you need to complete the spreadsheet assignment on simple addition. Remember, you are saving \$100 per month for 20 years…

Continue

Where is a good place to vacation? Click the location on the map to proceed.

Go back

Click on the U-turn to try again

Here is your hint to get to the next section….

76.2% of American households have at least 1 credit card, bank card, or store card.

Hint: you’d better write that number down somewhere, you’re going to need it! Now go back to the main menu and complete the next section.

By now you should have completed the Simple Addition spreadsheet. If you did then answer the question below. If you didn’t, then go back and do it.

What percentage of American households have no credit cards, no bank cards and no store cards? (Click on the correct answer)

A. 3%

B. 23.8%

C. 13.5%

D. 42.6%

Now we’re going to see how much money you would have if you put that \$100 per month into the bank and cleaned out the bank account at the end of each year and started over.

So you want to learn about compound interest? First let’s see if you finished the section on simple interest

How much more money does a college graduate earn over a high-school grad?

50% More \$\$

4 times as much \$\$

2 times as much \$\$

Go Back

Some people are afraid to put their money into a bank, especially in today’s economy. But banks pay interest so you can earn more on your savings. Also, your savings are insured by the Federal Deposit Insurance Company (FDIC) up to \$100,000. So even if your bank goes out of business, you’ll still get your money. So what if you left the money in the bank and earned interest for 20 years. How much would you have then? To find out, we’ll first have to learn about compound interest…

Continue

In the last spreadsheet you completed, you simply added up the interest from each year. But that’s not how it works in reality. Each year you earn interest, you add that interest to your principle and it becomes part of it. So next year, you earn money on the new principle which includes last year’s interest. Let’s look at an example…

Continue

Let’s say we start with \$1,000 which we put in the bank at an APR of 4%. So at the end of year 1, you would have \$1,000 x .04 = 40 (that’s the interest)

\$1,000 + 40 = \$1,040 (that’s your total)

Continue

At the end of year 1, you would have \$1,000 + 40 = \$1,040

So year 2, you would start with \$1040 as your principle and earn interest of 4% on that: \$1,040 x .04 = 41.60

\$1,040 + 41.60 = \$1081.60

Continue

At the end of year 2, you would have

\$1,040 + 41.60 = \$1081.60

Notice that the interest for year 1 was \$40 while the interest for year 2 was \$41.60. Year 3, the interest will be even more because each year the principle increases as you add the interest from the previous year.

Continue

Now let’s work up a simple spreadsheet that shows us how this compound interest works. We will take \$500 principle and calculate compound interest of 6% APR for 5 years.

Click on “Continue” to see a sample spreadsheet.

Continue

By now you should be able to create this spreadsheet without any trouble. So go ahead and try. If you get stuck, there is help built-in. Remember, you have to submit the spreadsheet, so you can’t just type in the numbers, you have to use formulas.

Continue

By now you’ve figured out that compound interest is all about time. Actually, we refer to compound interest at “the time value of money.” The spreadsheet you just built was easy, but not very realistic. You see, most banks compute interest on a monthly basis, using an annual rate. The math to do this is easy in theory…

You simply take the APR and divide by 12 to get the monthly interest rate.

Example: APR = 10%

.10/12 = .0833 So you would multiply the principle by .0833 each month. But remember, you need to add the interest each month as well. So let’s look at what our spreadsheet would look like for our last example…

Continue

This is getting to be a pretty big spreadsheet and we’ve only done 1 year’s worth! Now imagine building a spreadsheet to calculate our original problem of saving \$100 per month for 20 years!! There has to be an easier way…

Continue

Want a faster way to calculate the future value of your investment? Well we’ve got it. Take a look at the right side of the spreadsheet. Excel has a formula called FV (future value) and all you have to do is plug in the variables and have Excel calculate the interest for you.

Continue

Compound Interest-12The FV Formula

The formula for future value is: FV(rate,nper,pmt,pv,type)

• Rate   is the interest rate per period. Remember to divide by 12 for monthly interest.

• Nper   is the total number of payment periods in an annuity. So 12 x #years for monthly interest.

• Pmt   is the payment made each period; it cannot change over the life of the annuity. If pmt is omitted, you must include the pv argument.

• Pv   is the present value, or the lump-sum amount that a series of future payments is worth right now. (Another way to think of this is the money you start with). If pv is omitted, it is assumed to be 0 (zero), and you must include the pmt argument.

• Type   is the number 0 or 1 and indicates when payments are due. If type is omitted, it is assumed to be 0.

• Set type equal to 0 if payments are due at the end of the period 1 At the beginning of the period. (You can skip this for our purposes).

Important note: when you enter Pmt or PV you must enter them as a negative value, i.e. -100 or your final answer will show as a negative.

Continue

Now it’s time to use the FV formula to figure out how much money we will have after 20 years.

Continue

So what did you get?

After 20 years of saving \$100 per month at 6% APR, you would have an approximate total of…

\$24,000

\$25,200

\$41,100

\$32,000

Go Back

APR stands for:

Annual Partial Rate

Actual Percentage Rate

Annual Percentage Rate

Next Question

Bob put \$1,000 in the bank for a year. At the end of the year, he had \$1,050 in his account. The \$1,000 he started with is called the:

Base

Principal

Foundation

Next Question

Principle

Bob borrowed \$5,000 from the bank for a year. At the end of the year, he paid back \$5,500. The \$500 he paid is called the:

Bonus

Interest

Penalty

Next Question

Bribe

Bob put \$5,000 into the bank at an APR of 6%. The interest was calculated each month at a rate of .06/12=.0005 This is an example of:

Simple Interest

Variable Interest

Reduced Interest

Next Question

Compound Interest

Bob put \$10,000 into the bank at an APR of 7%. At the end of the year he had \$10,700 in his account. The bank must be using:

Simple Interest

Variable Interest

Reduced Interest

Next Question

Compound Interest

Bob put \$10,000 into the bank at an APR of 8%. The bank uses simple interest. At the end of the year Bob will have:

\$10,080

\$10,800

\$10,000

Next Question

It depends on current interest rates.

The FDIC makes sure your money is safe when you put it into a bank. FDIC stands for:

Federal Deposit Insurance Capital

First Deposit Is Covered

Federal Deposit Insurance Corporation

Next Question

First Definitive Interest Charge

In the FV(rate,nper,pmt,pv,type) formula that we used in Excel, “pmt” represents:

The payment you make each month into your savings account.

The payment you get each month from the interest earned.

The payment you get at a future date.

Next Question

In the FV(rate,nper,pmt,pv,type) formula that we used in Excel, if the APR was 12%, the “rate” would be:

6%

12%

1%

Next Question

3%

In the FV(rate,nper,pmt,pv,type) formula that we used in Excel, if you were saving money for 10 years, the “nper” would be:

10

12

100

Next>

120

Go back and try again.

So, by simply adding up your \$100 per month, you would save \$24,000 over 20 years. If you put that same money in the bank at an APR of 5%, you would end up with over \$41,000 thanks to compound interest!

If you haven’t completed the quiz, go back to the main menu and give it a try!