Continuous Compounding – The Curious Case of e
Let’s look at a shortcut to calculate continuous compound interest using Euler’s number e . The popular formula for compound interest is: Where: t =number of years, A = final amount after t years, r =interest rate per annum. The formula assumes that the interest rate is compounded once a year. If interest rates are compounded more frequently, the formula is: Where n is the yearly compounding frequency. Say we want to find out the compound rate of return, r , given the following: P =100000, A =8000000, t =25 years, with compounding frequency set to 1 per year. To calculate r , we can use (2) with n =1: Rearranging the terms, we get: To simplify the calculation, we may also use logarithms on the expression for (2): Therefore, r =0.1915 or 19.15% per year. In other words, if we compounded 100000 at the rate of 19.15%, once a year, for 25 years, we would end up with 8000000. Let’s increase the compounding frequenc...