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Principles of finance ah la shmoop semi annual versus daily

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compounding in bonds effective rate All right people This natty

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concept takes into effect the compound ing period That is

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if two bonds are identical in every way except that

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one comp pounds daily and the other compounds semi annually

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while the daily compound er will effectively yield you more

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greenbacks All right if we have an investment of one

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hundred grand in a bond yielding six percent it'll pay

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us three grand in six months And if we just

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kept that cash in the same bond vehicle we now

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have one hundred three thousand on which to then receive

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annualized interest right Like we get that three grand after

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six months we just reinvested in the same bond and

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our com pounding on one hundred three grand right So

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said another way So for the next semi annual period

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we get a three percent return on one hundred three

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grand instead of three percent on just the hundred grand

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that we started with case that's semi annual compounding But

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with daily compounding we get mohr Our little formula here

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should explain how on our first six months or one

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hundred eighty two days of the year we get three

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percent of one plus the quantity one over one eighty

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two it's the same is six percent of the quantity

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won over three sixty four right But after one day

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of one hundred thousand dollars bond we'd have like one

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hundred thousand dollars plus roughly three thousand dollars divided by

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one eighty two which is about sixteen bucks and change

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So then on day two we're compounding on a higher

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base principle of one hundred thousand sixteen dollars Well doesn't

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seem like much but you that every day for a

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whole lot of days it really adds up So what

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if you have a bond yielding twelve percent and it

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actually pays awfully well you owned it five years and

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you think you made a killing homerun right Not necessarily

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What if these work brazilian bonds issued so that they

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were payable in the brazilian currency The ray al Well

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during the five years you owned that twelve percent yielding

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bond brazil saw inflation of twenty percent a year So

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you lost eight percent When you collect your principal at

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the end of these five years you'll go shopping for

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a car and woops It turns out that you actually

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lost eight percent a year at least eight percent a

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year in buying power Your nominal twelve percent yield Actually

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violent stunk You're real Return was a loss of eight 00:02:21.13 --> [endTime] percent a year Nice job there pal

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