VIEWS: 133 PAGES: 45 CATEGORY: Personal Finance POSTED ON: 6/30/2010 Public Domain
Interest Interest Interest Interest Interest Interest Asst. Professor D. Urmston Interest SUNY Orange Begin Learning Objectives • Understand the concept of compound interest • Calculate compound interest using a spreadsheet • Compare the results of simple addition, simple interest and compound interest for a given situation Continue Learning Objectives- The problem We want to see the difference compound interest can make when someone saves for the future. So imagine you are faced with a choice: 1. Save your money in a jar ($100/month for 20 years.)(Simple Addition) 2. Put your money in the bank but then take it out at the end of each year and put it in the jar ($100/month for 20 years).(Simple Interest) 3. Put your savings into the bank as you earn it and earn compound interest ($100/month for 20 years- leaving it in the bank).(Compound Interest) We know that you will have more money under situation 3, but how much more? Continue Main Menu How it works: You start with the tutorial and progress through the 3 types of savings. You must complete the work for each section before you can move on to the next section. You may skip the tutorial if you wish. You may return to the main menu at any time to repeat a section or to view the learning objectives 1 2 3 Tutorial- Spreadsheet Basics Simple Addition Simple Interest 4 5 Compound Interest Quiz Learning Objectives Tutorial – Menu How to navigate a Basic spreadsheet spreadsheet formulas If the Flash tutorials are not working, click here for the alternate video viewer Advanced formulas Copying Formulas Main Menu Alternate Tutorials Directions: Click on the film reel on the left and a video viewer will open. (It may take a few minutes). Once the video viewer is open, choose File>>> Quick Open File>>> from the drop down menu choose the CD then open the folder Interest Click Here Project>>>Tutorials Watch the tutorials in this order: 1. Navigation 2. Basic_formulas 3. Advanced formulas 4. Copying1 5. Copying2 When you are done, return to the main menu and continue with the next section. Main Menu Tutorial – Navigation How to navigate a spreadsheet Click to play tutorial. A new window will open. When you are finished with the tutorial, close the window. Tutorial Menu Main Menu Tutorial – Basic formulas Basic spreadsheet formulas Click to play tutorial. A new window will open. When you are finished with the tutorial, close the window. Tutorial Menu Main Menu Tutorial – Advanced Formulas Advanced formulas Click to play tutorial. A new window will open. When you are finished with the tutorial, close the window. Tutorial Menu Main Menu Tutorial – Copying formulas Copying Formulas Click to play tutorial. A new window will open. When you are finished with the tutorial, close the window. Tutorial Menu Main Menu Simple Addition Welcome to the first step in your journey. All you have to do to move on is to answer the question on the following page. Oh, there is one catch…in order to answer the question, you need to complete the spreadsheet assignment on simple addition. Remember, you are saving $100 per month for 20 years… Continue Main Click me for the spreadsheet… Menu Simple Addition Where is a good place to vacation? Click the location on the map to proceed. Main Go back Menu Sorry, that was incorrect Click on the U-turn to try again Main Menu Correct! Here is your hint to get to the next section…. 76.2% of American households have at least 1 credit card, bank card, or store card. Hint: you’d better write that number down somewhere, you’re going to need it! Now go back to the main menu and complete the next section. Main Menu Simple Interest By now you should have completed the Simple Addition spreadsheet. If you did then answer the question below. If you didn’t, then go back and do it. What percentage of American households have no credit cards, no bank cards and no store cards? (Click on the correct answer) A. 3% B. 23.8% C. 13.5% D. 42.6% Main Menu You didn’t write down that number did you? Click Here to Try Main Again! Menu Simple Interest Now we’re going to see how much money you would have if you put that $100 per month into the bank and cleaned out the bank account at the end of each year and started over. Click here to begin the next spreadsheet project Main Menu Compound Interest-1 So you want to learn about compound interest? First let’s see if you finished the section on simple interest How much more money does a college graduate earn over a high-school grad? 50% More $$ 4 times as much $$ 2 times as much $$ Main Go Back Menu Compound Interest-2 Some people are afraid to put their money into a bank, especially in today’s economy. But banks pay interest so you can earn more on your savings. Also, your savings are insured by the Federal Deposit Insurance Company (FDIC) up to $100,000. So even if your bank goes out of business, you’ll still get your money. So what if you left the money in the bank and earned interest for 20 years. How much would you have then? To find out, we’ll first have to learn about compound interest… Continue Main Menu Compound Interest-3 In the last spreadsheet you completed, you simply added up the interest from each year. But that’s not how it works in reality. Each year you earn interest, you add that interest to your principle and it becomes part of it. So next year, you earn money on the new principle which includes last year’s interest. Let’s look at an example… Continue Main Menu Compound Interest-4 Let’s say we start with $1,000 which we put in the bank at an APR of 4%. So at the end of year 1, you would have $1,000 x .04 = 40 (that’s the interest) $1,000 + 40 = $1,040 (that’s your total) Continue Main Menu Compound Interest-5 At the end of year 1, you would have $1,000 + 40 = $1,040 So year 2, you would start with $1040 as your principle and earn interest of 4% on that: $1,040 x .04 = 41.60 $1,040 + 41.60 = $1081.60 Continue Main Menu Compound Interest-6 At the end of year 2, you would have $1,040 + 41.60 = $1081.60 Notice that the interest for year 1 was $40 while the interest for year 2 was $41.60. Year 3, the interest will be even more because each year the principle increases as you add the interest from the previous year. Continue Main Menu Compound Interest-7 Now let’s work up a simple spreadsheet that shows us how this compound interest works. We will take $500 principle and calculate compound interest of 6% APR for 5 years. Click on “Continue” to see a sample spreadsheet. Continue Main Menu Compound Interest-8 Interest rate = 0.06 Year Principle Interest Ending Balance Y1 $500.00 $30.00 $530.00 Y2 $530.00 $31.80 $561.80 Y3 $561.80 $33.71 $595.51 Y4 $595.51 $35.73 $631.24 Y5 $631.24 $37.87 $669.11 By now you should be able to create this spreadsheet without any trouble. So go ahead and try. If you get stuck, there is help built-in. Remember, you have to submit the spreadsheet, so you can’t just type in the numbers, you have to use formulas. Continue Click here to build your spreadsheet Main Menu Compound Interest-9 By now you’ve figured out that compound interest is all about time. Actually, we refer to compound interest at “the time value of money.” The spreadsheet you just built was easy, but not very realistic. You see, most banks compute interest on a monthly basis, using an annual rate. The math to do this is easy in theory… You simply take the APR and divide by 12 to get the monthly interest rate. Example: APR = 10% .10/12 = .0833 So you would multiply the principle by .0833 each month. But remember, you need to add the interest each month as well. So let’s look at what our spreadsheet would look like for our last example… Continue Main Menu Compound Interest-10 APR= 0.06 Monthly Interest rate= 0.005 Month Principle Interest Ending Balance M1 $500.00 $2.50 $502.50 M2 $502.50 $2.51 $505.01 M3 $505.01 $2.53 $507.54 M4 $507.54 $2.54 $510.08 M5 $510.08 $2.55 $512.63 M6 $512.63 $2.56 $515.19 M7 $515.19 $2.58 $517.76 M8 $517.76 $2.59 $520.35 M9 $520.35 $2.60 $522.96 M10 $522.96 $2.61 $525.57 M11 $525.57 $2.63 $528.20 M12 $528.20 $2.64 $530.84 This is getting to be a pretty big spreadsheet and we’ve only done 1 year’s worth! Now imagine building a spreadsheet to calculate our original problem of saving $100 per month for 20 years!! There has to be an easier way… Continue Main Menu Compound Interest-11 APR= 0.06 Monthly Interest rate= 0.005 Month Principle Interest Ending Balance M1 $500.00 $2.50 $502.50 OR WE COULD JUST DO THIS! M2 $502.50 $2.51 $505.01 FV= $530.84 M3 $505.01 $2.53 $507.54 M4 $507.54 $2.54 $510.08 M5 $510.08 $2.55 $512.63 M6 $512.63 $2.56 $515.19 M7 $515.19 $2.58 $517.76 M8 $517.76 $2.59 $520.35 M9 $520.35 $2.60 $522.96 M10 $522.96 $2.61 $525.57 M11 $525.57 $2.63 $528.20 M12 $528.20 $2.64 $530.84 Want a faster way to calculate the future value of your investment? Well we’ve got it. Take a look at the right side of the spreadsheet. Excel has a formula called FV (future value) and all you have to do is plug in the variables and have Excel calculate the interest for you. Continue Main Menu Compound Interest-12 The FV Formula The formula for future value is: FV(rate,nper,pmt,pv,type) • Rate is the interest rate per period. Remember to divide by 12 for monthly interest. • Nper is the total number of payment periods in an annuity. So 12 x #years for monthly interest. • Pmt is the payment made each period; it cannot change over the life of the annuity. If pmt is omitted, you must include the pv argument. • Pv is the present value, or the lump-sum amount that a series of future payments is worth right now. (Another way to think of this is the money you start with). If pv is omitted, it is assumed to be 0 (zero), and you must include the pmt argument. • Type is the number 0 or 1 and indicates when payments are due. If type is omitted, it is assumed to be 0. • Set type equal to 0 if payments are due at the end of the period 1 At the beginning of the period. (You can skip this for our purposes). Important note: when you enter Pmt or PV you must enter them as a negative value, i.e. -100 or Continue your final answer will show as a negative. Main Menu Compound Interest-13 Now it’s time to use the FV formula to figure out how much money we will have after 20 years. Continue Click here to complete the Main spreadsheet Menu Compound Interest-14 So what did you get? After 20 years of saving $100 per month at 6% APR, you would have an approximate total of… $24,000 $25,200 $41,100 $32,000 Main Go Back Menu Quiz page-1 APR stands for: Annual Partial Rate Actual Percentage Rate Annual Percentage Rate Next Question Adjusted Percentage Ratio Main Menu Quiz page-2 Bob put $1,000 in the bank for a year. At the end of the year, he had $1,050 in his account. The $1,000 he started with is called the: Base Principal Foundation Next Question Principle Main Menu Quiz page-3 Bob borrowed $5,000 from the bank for a year. At the end of the year, he paid back $5,500. The $500 he paid is called the: Bonus Interest Penalty Next Question Bribe Main Menu Quiz page-4 Bob put $5,000 into the bank at an APR of 6%. The interest was calculated each month at a rate of .06/12=.0005 This is an example of: Simple Interest Variable Interest Reduced Interest Next Question Compound Interest Main Menu Quiz page-5 Bob put $10,000 into the bank at an APR of 7%. At the end of the year he had $10,700 in his account. The bank must be using: Simple Interest Variable Interest Reduced Interest Next Question Compound Interest Main Menu Quiz page-6 Bob put $10,000 into the bank at an APR of 8%. The bank uses simple interest. At the end of the year Bob will have: $10,080 $10,800 $10,000 Next Question It depends on current Main interest rates. Menu Quiz page-7 The FDIC makes sure your money is safe when you put it into a bank. FDIC stands for: Federal Deposit Insurance Capital First Deposit Is Covered Federal Deposit Insurance Corporation Next Question First Definitive Main Interest Charge Menu Quiz page-8 In the FV(rate,nper,pmt,pv,type) formula that we used in Excel, “pmt” represents: The payment you make each month into your savings account. The payment you get each month from the interest earned. The payment you get at a future date. Next Question The amount you start with before you begin saving each month. Main Menu Quiz page-9 In the FV(rate,nper,pmt,pv,type) formula that we used in Excel, if the APR was 12%, the “rate” would be: 6% 12% 1% Next Question 3% Main Menu Quiz page-10 In the FV(rate,nper,pmt,pv,type) formula that we used in Excel, if you were saving money for 10 years, the “nper” would be: 10 12 100 Next> 120 Main Menu Sorry, that’s incorrect Go back and try again. Main Menu Correct! Click here, then go on to the next question! Main Menu You’re done! So, by simply adding up your $100 per month, you would save $24,000 over 20 years. If you put that same money in the bank at an APR of 5%, you would end up with over $41,000 thanks to compound interest! If you haven’t completed the quiz, go back to the main menu and give it a try! Main Menu You’re done! So, how did you do on the quiz? Take quiz Main again Menu