What is Continuous Compounding
Continuous compounding refers to the process of accumulating the time value of money continuous and on an instantaneous basis. As interest is earned and accrued at every turn the interest that has been earned begins to earn interest on immediately. This means that if a loan has is being charged continuous compound interest the rates will continue rising all the time. The interest will be added to the loan balance as it begins to earn interest immediately. Continuous compounding tends to yield the same interest rates as daily compound interest only that this is in the long term. The only difference is that the compound interest will earn much more due to the time it may take to have the loan repaid.
Albert Einstein was once quoted as saying that continuous compound interest is one of the most powerful forces in the world due to the revenue its likely to raise for the person. One of the most interesting things is that it accumulates a lot of money in a very short interval. Financial experts argue that though the compound interest may sound quite lofty, its yields are similar to daily compounding. A bank account that has interest that is compounded with a principal sum of $100 at a 20 percent interest every year. At the end of the year it will have accumulated a balance of $1200 and the sum will continue to rise every year.
In order for one to understand this concept fully and compare other interest rates with the compound interest it’s important for one to disclose the compounding interest frequency. People tend to perceive interest rates on an annual basis and even most of the governments require financial facilities to disclose the compound interest on any balance or advance. One of the ways of realizing the real implications of compound interest is by comparing it to the simple interest where interest is not added to the principal amount. Simple interest is not commonly used unlike compounded interest which is a favorite of financial institutions.
Compounded interest is affected by the frequency at which it’s charged and the rate at which the interest is charged. The higher the interest the higher the figure that will be added to the principal will be, at the same time the frequency of compounding interest will also affect the interest that will end up being added to the principal. Continuous compounding is seen as a way of making the compounding time span infinitesimally small. This is usually achieved through taking a limit to infinity. Converting interest rates from compound to another involves using the formula such as r1 as the stated interest while the frequency of the compound is n1 and r2 as the stated rate of the compounded interest rates.
Due to its ability to accumulate a very tidy sum of money in a very short duration continuous compounding of interest has long been considered as one of the worst forms of usury. Most of the early civilizations and religions highly discouraged the practice.