Page 56 - CFA - Day 1 & 2 Course Notes
P. 56
LOS 6.d: Solve time value of money Session Unit 2: The Time Value of Money
problems for different frequencies of
compounding.
Example: Growth with quarterly compounding
John plans to invest $2,500 in an account that will earn 8% per year with quarterly
compounding. How much will be in the account at the end of two years?
Answer:
Scenario 1: There are 8 quarterly compounding periods in 2 years, and the
effective quarterly rate is 8 / 4 = 2%.
The account will grow to 2,500(1.02)8 = $2,929.15.
Scenario 2:
Alternatively, since the EAR is 1.024 – 1 = 0.082432,
we can grow the $2,500 at 8.2432% for two years to get
2,500(1.082432)2 = $2,929.15, which is the same result.
