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A311 (2/5/2009) Interest Compounding Periods ------------------------- Financial contracts generally specify how often contractual  interest is compounded each  year for determining contractual interest payments Example : Interest-bearing security (e.g. government bond) with semi-annual interest  compounding at 10% (annual rate), and initial principal balance of security is \$1000. Value 0  = 1000 semi- Value .5  = 1000[1 + .10(6/12)] = 1050 annual Value 1  = 1050[1 + .10(6/12)] = 1102.5 compounding Contrast with annual compounding: Value .5  = 1000[1 + .10(6/12)] = 1050 annual Value 1  = 1000[1 + .10(12/12)] = 1100 compounding Note : “compounding” refers only  to contractual interest Generally (but not always) accountants modify present value calculations based on contractual  interest compounding provisions; Example: PV 0  = (p 1  +i 1 )•R -1  = (p 1  + i 1 )(1 + r/m) -1•m m=# of compounding periods per year

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