Exercise 5.4 · Q14
Q.From this graph, what conclusion can be drawn regarding the frequency of compounding? (Adapted from Finance and Growth) [Graph description: "The Growth of £1 at r = 20% using different compounding frequencies" — value (£'s) on the y-axis (0 to 160) plotted against year (1 to 25) on the x-axis, for four compounding frequencies: Annually, Quarterly, Monthly, and Daily. All four curves show exponential growth over the 25 years. The Annually curve is visibly the lowest throughout, reaching roughly £95 by year 25. The Quarterly, Monthly and Daily curves stay close together and clearly above the Annually curve, with Daily finishing highest at roughly £148, Monthly close behind at roughly £143, and Quarterly slightly lower at roughly £132 by year 25 — i.e. more frequent compounding produces a visibly larger total return.]
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Start your 14-day free trial to unlock the full solution →Compare the four compounding-frequency curves () at using , and connect the ordering seen on the graph to the continuous-compounding limit.
Value after years, compounded times per year at nominal rate : . As (continuous compounding): , since .
- Take , , years, and evaluate for each frequency shown on the graph.
- Annually (): — matches the lowest curve (~£95 at year 25).
- Quarterly (): — matches the graph (~£132).
- Monthly (): — matches the graph (~£143).
- Daily (): — matches the graph (~£148), and this is already very close to the continuous limit .
- Ordering: Annually Quarterly Monthly Daily, exactly as the graph shows — for the same nominal rate, more compounding periods per year always give a strictly larger final value. …
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