Continuous là gì
What is Continuously Compounded Return?
Continuously compounded return is what happens when the interest earned on an investment is calculated and reinvested bachồng inlớn the account for an infinite number of periods. The interest is calculated on the principal amount & the interest accumulated over the given periods & reinvested bachồng inkhổng lồ the cash balance.
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Regular compounding is calculated over specific time intervals such as monthly, quarterly, semi-annually and on an annual basis. Continuous compounding is an extreme case of this type of compounding since it calculates interest over an infinite number of periods, rather than assuming a specific number of periods. The difference between the interest earned through the traditional compounding method và the continuous compounding method may be significant.
Annual Compounding vs. Continuously Compounded Return
Investors calculate the interest or rate of returnRate of ReturnThe Rate of Return (ROR) is the gain or loss of an investment over a period of time copmared to the initial cost of the investment expressed as a percentage. This guide teaches the most common formulas on their investments using two main techniques: annual compounding và continuous compounding.
Annual compoundingAnnual compounding means that the return on an investment is calculated every year, và it is different from simple interest. The annual compounding method uses the following formula:
Total =
The return on investment is obtained by deducting the principal amount from the total returns obtained using the above formula.
Assume that Company ABC invested $10,000 khổng lồ purchase a financial instrument, và the rate of return is 5% for two years. Therefore, the interest earned from ABC’s investment for the two-year period is as follows:
= <10,000 x (1+0.05)^2
= (10,000 x 1.1025)
= 11,025 – 10,000
= $1,025
Therefore, Company ABC earned interest of $1,025 on its investment of $10,000 over two years.
Continuously Compounded ReturnUnlượt thích annual compounding, which involves a specific number of periods, the number of periods used for continuous compounding is infinitely numerous. Instead of using the number of years in the equation, continuous compounding uses an exponential constant lớn represent the infinite number of periods. The formula for the principal plus interest is as follows:
Total = Principal x e^(Interest x Years)
Where:
e – the exponential function, which is equal to lớn 2.71828.Using Company ABC example above, the return on investment can be calculated as follows when using continuous compounding:
= 10,000 x 2.71828^(0.05 x 2)
= 10,000 x 1.1052
= $11,052
Interest = $11,052 – $10,000
= $1,052
The difference between the return on investmentReturn on Investment (ROI)Return on Investment (ROI) is a performance measure used lớn evaluate the returns of an investment or compare efficiency of different investments. when using continuous compounding versus annual compounding is $27 ($1,052 – $1025).
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Daily, Monthly, Quarterly,and Semi-annual Compounding
Apart from the annual & continuous compounding methods, interest can also be compounded at different time intervals such as daily, monthly, quarterly and semi-annually.
To illustrate compounding at different time intervals, we take an initial investment of $1,000 that pays an interest rateInterest RateAn interest rate refers khổng lồ the amount charged by a lender lớn a borrower for any form of debt given, generally expressed as a percentage of the principal. of 8%.
Daily compoundingThe formula for daily compounding is as follows:
= Principal x (1+Interest/365)^365
= 1,000 x (1 + 0.08/365) ^ 365
= 1,000 x (1 + 0.00022)^365
= 1,000 x (1.00022) ^ 365
= 1,000 x 1.0836
= $1,083.60
Monthly compoundingThe formula for the monthly intervals is as follows:
= Principal x (1+Interest/12)^12
= 1,000 x (1+0.08/12) ^12
= 1,000 x <1+0.0067)^12
= 1,000 x (1.0067)^12
= 1,000 x (1.083)
= $1,083.00
Quarterly compoundingThe formula for quarterly compounding is as follows:
= Principal x (1 + interest/4)^4
= 1,000 x (1 +0.08/4)^4
= 1,000 x (1 + 0.02)^4
= 1,000 x (1.02)^4
= 1,000 x 1.0824
= $1,082.40
Semi-annual compoundingThe formula for semi-annual compounding is as follows:
= Principal x (1 + interest/2)^2
= 1,000 x (1 + 0.08/2)^2
= 1,000 x (1 + 0.04)^2
= 1,000 x (1.04)^2
= 1,000 x 1.0816
= $1,081.60
Conclusion on Compounding IntervalsFrom the above calculations, we can conclude that all the intervals produce an almost equal interest, but with a small variation. For example, quarterly compounding produces an interest of $82.40, which is slightly higher than the interest produced by semi-annual compounding at $81.60.
Also, the monthly rate yields an interest of $83, which is slightly higher than the interest produced by quarterly rates at $82.40. Daily compounding yields a higher interest of $83.60, which is slightly higher than the interest at monthly rates of $82.60.
From the pattern above, we can also say that small interest compounding intervals produce higher interest rates compared to large compounding intervals.
Importance of Continuous Compounding
Continuous compounding offers various benefits over simple interestSimple InterestSimple interest formula, definition & example. Simple interest is a calculation of interest that doesn"t take into tài khoản the effect of compounding. In many cases, interest compounds with each designated period of a loan, but in the case of simple interest, it does not. The calculation of simple interest is equal khổng lồ the principal amount multiplied by the interest rate, multiplied by the number of periods. và regular compounding. The benefits include:
1. Reinvest gains perpetuallyOne of the benefits of continuous compounding is that the interest is reinvested into lớn the tài khoản over an infinite number of periods. It means that investors enjoy the continuous growth of their portfoltiện ích ios, as compared khổng lồ when they earn interest monthly, quarterly, or annually with regular compounding.
2. Interest amount will keep on growingIn continuous compounding, both the interest and the principal keep on growing, which makes it easier to lớn multiply the returns in the long term. Other forms of compounding only earn interest on the principal & that interest is paid out as it is earned. Reinvesting the interest allows the investor to earn at an exponential rate for an infinite number of periods.
Additional Resources
Thank you for reading CFI’s explanation of continuously compounded return. CFI offers the Financial Modeling & Valuation Analyst (FMVA)™Become a Certified Financial Modeling và Valuation Analyst (FMVA)® certification program for those looking lớn take their careers to lớn the next cấp độ. To keep learning & advancing your career, the following CFI resources will be helpful:
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