HP 10bII+ - Interest Rates

Picturing Financial Problems
57
Compound Interest
A compound-interest contract is like a series of simple-interest contracts that are connected.
The length of each simple-interest contract is equal to one compounding period. At the end
of each period the interest earned on each simple-interest contract is added to the principal.
For example, if you deposit 1,000.00 in a savings account that pays 6% annual interest,
compounded monthly, your earnings for the first month look like a simple-interest contract
written for 1 month at
1
/
2
% (6% ÷ 12). At the end of the first month the balance of the account
is 1,005.00 (5 is
1
/
2
% of 1,000).
The second month, the same process takes place on the new balance of 1,005.00. The
amount of interest paid at the end of the second month is
1
/
2
% of 1,005.00, or 5.03. The
compounding process continues for the third, fourth, and fifth months. The intermediate results
in this illustration are rounded to dollars and cents.
Figure 3 Annual interest compounded monthly
The word compound in compound interest comes from the idea that interest previously earned
or owed is added to the principal. Thus, it can earn more interest. The financial calculation
capabilities of the HP 10bII+ are based on compound interest.
Interest Rates
When you approach a financial problem, it is important to recognize that the interest rate or
rate of return can be described in at least three different ways: