Getting familiar with some terms
- Present value (PV). The amount of money needed today to purchase certain goods.
- Future value (FV). The amount of money at the end of the investment period equal to the present value plus accrued compound interest.
- Number of periods (N). The total number of compounding periods in the term.
- Rate (r). The annual interest rate divided by the number of compounding periods per year, sometimes referred to as "the discount."
- Payments (PMT). Payments made to or from the investment during each compounding period, if any.
- Beginning (BEG)/end (END). The time when payments are made. It can be either at the beginning of a compounding period (BEG) or at its end (END).
Using our example above, the present value is $100. Its future value is $112.68. There are 12 compounding periods (N). The rate is 1% per period (12%/12). In this example, there are no other payments at the beginning or end of a compounding period.
Here is another example using a typical mortgage loan. A $100,000 (PV) loan at 6% compounded monthly (r = 6% / 12 = 0.5%) for 30 years (N = 30 x 12 = 360 periods) has a future value of $602,258. If payments of $599.55 for principal and interest are made at the end of each month, then the total loan repayment will be only $215,838 (599.55 x 360), since some loan principal and interest were paid each compounding period.
With compound interest, it pays to make principal and interest payments each month.