Posted by **Anonymous** on Saturday, January 24, 2009 at 4:48pm.

If a bank offers interest at a nominal rate of 6%, how much greater is the effective rate if interest is compounded continuously than if the compounding is quarterly?

I don't get this question at all... All I'm given is the rate and how am I suppose to compare compounded continuously and quarterly if I'm not given the initial value, time and so on...

- Math - Compound -
**Damon**, Saturday, January 24, 2009 at 5:20pm
well, lets compare both to compounding once a year for n years.

Once a year

final/original = 1.06^n

Four times a year

6/4 = 1.5% per quarter

final/original = 1.015^4n

Continuously

final/original = e^.06 n

Well, lets see how four times a year compares to once a year

compare 1 = 1.015^4n / 1.06^n

ln compare 1 = 4 n ln 1.015 - n ln 1.06

= n(.05955445-.0582689) = .0012855419 n

so

compare 1 = e^.0012855419 n

or .12855 % better than once a year

Now do the same for continuous

compare 2 = e^06 n / 1.06^n

ln compare 2 = .06 n - n ln 1.06

= .001731 n

compare 2 = e^.001731 n

or .1731 % better than once a year

- Math - Compound -
**drwls**, Saturday, January 24, 2009 at 5:24pm
Quarterly componding of interest after one year at 6% annual rate gives you an annual yield of

(1 + 0.06/4)^4 - 1 = 6.136%

Continuous compounding requires you to consider limits. The answer is

Limit (as n approaches infinity) of

1 + 0.06/n)^n - 1

Calculus shows that this equals

e^(0.06) -1 = 6.184%

If you don't understand limits and e, consider the "daily interest" case, with n = 365. In that case the annual yield is 6.183%

- Easier -
**Damon**, Saturday, January 24, 2009 at 5:27pm
Just do them each for one year

yearly 1.06

quarterly

1.015^4 = 1.06136 or 6.136 % yearly

continuously

e^.06 = 1.06184 or 6.184 % yearly

- Math - Compound -
**Anonymous**, Saturday, January 24, 2009 at 5:43pm
thank you both for your help... I like Damon's method as it seems straightforward and I can follow it...

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