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f(x) = 3x
The following links explain
several aspects of
exponential functions.
Definition
Transformations of f(x) = 2x
Exponential Growth
Radioactive Decay
Money Matters
Simple Interest
Compound Interest
Continuous Interest
Effective Annual Rate
Ordinary Annuity
Loans
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Simple Interest
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Explanation
Simple interest is earned on the principal only.
Formula
At start:
T=P
After 1 period:
T = P + Pr = P(1 + 1r)
After 2 periods:
After 3 periods:
After n periods:
T = P(1 + nr)
Example calculation
If $200 dollars is invested and earns 8.0% simple interest, what is the final value of
the investment after 6 years?
T = P(1 + nr)
T = 200(1 + (6)(0.080))
T = $296
After entering values into the above input areas, click the following 'Calculate' button
to get T, the final value of the investment.
Compound Interest
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Explanation
Compound interest is paid both on the original principal and on the accumulated past
interest.
Formula
At start:
S=P
After 1 period:
S = P + Pr = P(1 + i)
Amount of interest earned during this period on the starting amount of this period
Final value at end of this period
After 2 periods:
Amount at the start of this period, i.e., the final value at the end of the last period
Amount of interest earned during this period on the starting amount of this period
After 3 periods:
Amount at the start of this period, i.e., the final value at the end of the last period
Amount of interest earned during this period on the starting amount of this period
After n periods:
S = P(1 + i)n
Often the interest per period, i, is expressed in terms of the annual percentage rate
(APR), r, and the number of interest periods per year, k.
Under these conditions the interest per period is equal to the annual percentage rate
divided by the number of interest periods per year, as in:
i=r/k
This would make the above formula for the final value of an investment after n
interest periods look like this:
S = P(1 + r/k)n
Notice that the output, S, is an exponential function of n. That is, if we consider the
final value of the investment as a function of the length of time for the investment,
then n, the length of time for the investment, is in the exponent position, and this
makes S an exponential function of n.
Example calculation
If $4000 is invested at an annual rate of 6.0% compounded monthly, what will be the
final value of the investment after 10 years?
Since the interest is compounded monthly, there are 12 periods per year, so, k = 12.
Since the investment is for 10 years, or 120 months, there are 120 investment periods,
so, n = 120.
S = P(1 + r/k)n
S = 4000(1 + 0.06/12)120
S = 4000(1.005)120
S = 4000(1.819396734)
S = $7277.59
P: r: k: n:
After entering values into the above input areas, click the following 'Calculate' button
to get S, the final value of the investment.
Continuous Interest
Function Institute Math Contents Index Home
Explanation
Continuous interest is a form of compound interest. With continuous interest the
length of the compounding period is reasoned to be infinitely small. The interest,
therefore, is compounded continuously.
Formula
S = Pert
Notice that the output, S, is an exponential function of t. That is, if we consider the
final value of the investment as a function of the length of time for the investment,
then t, the length of time for the investment, is in the exponent position, and this
makes S an exponential function of t.
Example calculation
If $4000 is invested at an annual rate of 6.0% compounded continuously, what will be
the final value of the investment after 10 years?
S = Pert
S = 4000e(0.06)(10)
S = 4000e0.6
S = 4000(1.822188)
S = $7288.48
P: r: t:
After entering values into the above input areas, click the following 'Calculate' button
to get S, the final value of the investment.
Explanation
The effective annual rate is a value used to compare different interest plans. If two
plans were being compared, the interest plan with the higher effective annual rate
would be considered the better plan. The interest plan with the higher effective annual
rate would be the better earning plan.
For every compounding interest plan there is an effective annual rate. This effective
annual rate is an imagined rate of simple interest that would yield the same final value
as the compounding plan over one year.
Formula
After a term of one year the final value, S, of a compounded interest investment with
an initial value P compounded k times per year at an annual percentage rate of r is
given by:
S = P(1 + r/k)k
After a term of one year the final value, S, of a simple interest investment with an
initial value P at an annual percentage rate of ieff is given by:
S = P(1 + ieff)
(1 + ieff) = (1 + r/k)k
ieff = (1 + r/k)k - 1
Example calculation
Which plan is the better investment plan?
Plan 1:
Plan 2:
ieff = (1 + r/k)k - 1
ieff = (1 + 0.08/12)12 - 1
ieff = (1.006666666)12 - 1
ieff = (1.082999498) - 1
ieff = 0.082999498
ieff = 8.2999%
ieff for plan 2:
ieff = (1 + r/k)k - 1
ieff = (1 + 0.079/365)365 - 1
ieff = (1.000216438)365 - 1
ieff = (1.082194930) - 1
ieff = 0.082194930
ieff = 8.2194%
First Plan
r: k:
Second Plan
r: k:
After entering values into the above input areas, click the following 'Calculate' button
to get ieff, the effective annual rate, for both plans.