Transcript Lesson 3.3 Compound Interest

Lesson 3.3
Compound Interest
Introduction
Compound interest is used in most financial transactions
It has been described as “simple interest on steroids”
According to some very smart people, it is essential for you to
understand compound interest
“Compounding is mankind’s greatest
invention because it allows for the
reliable, systematic accumulation of
wealth ”
Albert Einstein
1879 - 1955
February 15, 2011
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Lesson 3.3
Compound Interest
Objectives
You should be able to do the following after completing this lesson
• Define compound interest and compounding period
• Summarize why compound interest is so important
• Identify the type of interest used in financial transactions
• Explain why the principal for compound interest is dynamic
• Describe how to use compound interest to increase wealth
• Review what the Truth in Lending Act requires
• Describe the different interest rates used today
• Demonstrate how you would use the Rule of 72
February 15, 2011
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Lesson 3.3
Compound Interest
3.3.1 – Compound Interest
In this section, you will learn:
• What compound interest is
• What is unique about compound interest
• The components necessary to calculate compound interest
• How to calculate compound interest using this formula
CI  [ P  (1  R )  P ]
Y
February 15, 2011
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Lesson 3.3
Compound Interest
3.3.2 – Compound Interest’s Power
In this section, you will learn:
• How simple and compound interest are different
• What dynamic principal means to you
• Why everyone either loves or hates compound interest
• What a Growth Factor is
• How to calculate a Growth Factor using this formula
GF  (1  R )
Y
You will run the following Interactive Example:
• Principal Growth Example
February 15, 2011
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Lesson 3.3
Compound Interest
3.3.3 – The Compounding Period
In this section, you will learn:
• What the time between interest calculations is called
• What happens when the interest is calculated more
frequently
• The different compounding periods used with compound
interest
• How many times a year the compound interest is calculated
for different compounding periods
• What the actual annual interest rate for compound interest
depends on
February 15, 2011
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Lesson 3.3
Compound Interest
3.3.4 – Effective Interest Rate
In this section, you will learn:
• What financial institutions are required by law to show you
• What the effective interest rate is and what it is based on
• How the effective interest rate is calculated using this formula
EIR  [1  ( NIR  N )]
N
1
• What the APR is and why it is important
• When the effective interest rate is equal to the APR
• What the Truth in Lending Act is designed to do
You will run the following Interactive Example:
• Effective Interest Rate Example
February 15, 2011
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Lesson 3.3
Compound Interest
3.3.5 – Calculating Compound Interest
In this section, you will learn:
• Why just reading about compound interest doesn’t do it
justice
• When compound interest is working for you
• When compound interest is working against you
• Whether compound interest is more powerful when it is
working for or against you
February 15, 2011
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Lesson 3.3
Compound Interest
3.3.6 – Benefits of Compound Interest
In this section, you will learn:
• What the only proven way of becoming wealthy is
• How compound interest can help you become wealthy
• What ingredients are necessary to increase personal wealth
• What compound interest can do if given enough time
• What happens to the power of compound interest when the
interest rates are low
You will run the following Interactive Exercise:
• Compound Interest Exercise
February 15, 2011
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Lesson 3.3
Compound Interest
3.3.7 – Rule of 72
In this section, you will learn:
• What the Rule of 72 is
• How to calculate the Rule of 72 using this formula
Years  72  EIR
• Why you might want to use the Rule of 72
February 15, 2011
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Lesson 3.3
Compound Interest
Discussion Questions
Do you believe you can use the power of compound
interest to become wealthy?
Why did Congress pass the Truth in Lending Act?
February 15, 2011
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