Note on Problems with Nonannual Compounding

NOTE ON PROBLEMS WITH NONANNUAL COMPOUNDING

When you have nonannual compounding you must adjust the rate and the number of periods to match the compounding periods. In lump sum problems you won’t have to worry unless the problem specifies something other than annual compounding (e.g., semiannual compounding). In annuity problems you have to watch for how often the payments are made. Remember that an annuity is a series of cash flows of the same dollar amount. You could have daily, weekly, monthly, quarterly, semiannual or annual payments. If it is anything other than annual payments, you will have to adjust the rate and the number of periods.

Here are two examples:

1) A problem asks for the future value of $1000 in ten years if you deposit it in an account that pays 10%, compounded daily. You don’t earn 10% each day. The 10% is what is called the APR or annual percentage rate. You must convert