Assignment # 4
Describe the difference between discrete and continuous compounding interest?
Draw a general graph explaining their difference.
Discrete Compounding Interest
When interest is calculated and added to
the principal amount at specified intervals
i.e., monthly, quarterly, annually, then
such an interest is known as discrete
compounding interest.
In discrete compounding interest future
value F is calculated as:
r mt
F = P (1 + )
m where P = Principal Amount
where P = Principal Amount
r = Interest Rate
m = Number of Compounding
Periods per year
t = Term of contract in year
In general, discrete compounding interest
is less than continuous compounding
interest.
Example:
If a person has taken a loan of $1000 from
a bank for 15 years at an interest rate of
10% which is compounded once in a year
than using the formula for discrete
compounding interest the amount he will
have to pay after 15 years is $4177.25.
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Continuous Compounding Interest
When interest is being calculated at every
moment, strictly speaking, then such an
interest is known as continuous
compounding interest. It is calculated on
an exponential scale.
In continuous compounding interest future
value F is calculated as:
F = Pⅇrt
r = Interest Rate
t = Term of contract in year
e = Euler’s Number = 2.71828
Continuous compounding interest is
generally greater than discrete
compounding interest.
Example:
If a person has taken a loan of $1000 from
a bank for 15 years at an interest rate of
10% which is compounded continuously
than using the formula for continuous
compounding interest the amount he will
have to pay after 15 years is $4481.69.
Figure 1 shows how interest is compounded continuously and discretely in the above-
mentioned example

Figure 1: On left Discrete Compounding and on right continuous compounding is

depicted
Figure 2 shows how in continuous compounding future amount increases from discrete
compounding.

Figure 2: Variation of future amount in discrete and continuous compounding

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