Financial Math 1

Two key concepts in finance are compounding and discounting. Compounding refers to the fact that after each consecutive year we earn interest on a larger amount of money than the last

Example: If you invest 100 dollars and it compounds at 4% for 2 years how much money do you have? At first glance, you may think we have $108 but we, in fact, have $108.16.

In order to calculate the value after one year, we will multiply 100 *1.04, the1 at the beginning keeps our original hundred dollar investment intact and the .04 represents the 4% interest we earned. 100*1.04=104. In year two we multiply the 104*1.04 to come to 108.16.

Over multi-year periods we use expoents to simplify the calulation. For example, if we wanted to find the value of our 100 dollars after 30 years we would do the following:

Where:

P=principal

r= growth rate

n=number of years we grow the investment

Therefore our 100 dollar investment compounded at 4% for 30 years has a future value of 324.34

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