## Formula and Use

The periodic to continuous interest rate formula is used to convert a periodic interest rate (i) with compounding taking place (m) times in a period, into a continuous interest rate (r).

## Example 1: Using the Periodic to Continuous Interest Rate Formula

If an amount is invested at an annual rate of 5% compounded monthly, then the equivalent continuous interest rate is given as follows:

Continuous interest rate = r = m x LN(1 + i / m) i = 5% annual m = 12 (monthly compounding) Continuous interest rate = r = 12 x LN(1 + 5% / 12) Continuous interest rate = r = 4.9896%

This means that monthly compounding at a rate of 5% is the same as continuous compounding at a rate of 4.9896%.

To show that the two rates do in fact give the same result, suppose for example an amount of 5,000 is invested at a rate of 5% and compounded monthly for 3 years, then its future value is given as follows:

FV = PV x (1 + i)^{n}PV = 5,000 i = 5%/12 (monthly rate) n = 3 x 12 = 36 months FV = 5000 x (1 + 5%/12)^{36}FV = 5,807.36

If the same amount is invested with continuous compounding, then using our calculated rate above, the future value is given by

FV = PV x e^{rn}PV = 5,000 r = 4.9896% n = 3 FV = 5000 x e^{(4.9896% x 3)}FV = 5,807.36

The future value is each case is the same.

## Example 2: Using the Periodic to Continuous Interest Rate Formula

If an amount is invested at an annual rate of 6% compounded quarterly, then the equivalent continuous interest rate is given as follows:

Continuous interest rate = r = m x LN(1 + i / m) i = 6% annual m = 4 (quarterly compounding) Continuous interest rate = r = 4 x LN(1 + 6% / 4) Continuous interest rate = r = 5.9554%

This means that quarterly compounding at a rate of 6% is the same as continuous compounding at a rate of 5.9554%.

## Example 3: Using the Periodic to Continuous Interest Rate Formula

If an amount is invested at an annual rate of 8% compounded annually, then the equivalent continuous interest rate is given as follows:

Continuous interest rate = r = m x LN(1 + i / m) i = 8% annual m = 1 (annual compounding) Continuous interest rate = r = 1 x LN(1 + 8% / 1) Continuous interest rate = r = 7.6961%

This means that annual compounding at a rate of 8% is the same as continuous compounding at a rate of 7.6961%.

The periodic to continuous interest rate formula is one example of an annuity formula used in time value of money calculations, discover another at the link below.

## About the Author

Chartered accountant Michael Brown is the founder and CEO of Plan Projections. He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a BSc from Loughborough University.