5 - Continuous Compounding

Question 1

Explain the process of Compounding interest?

Answer 1

Compounding interest is the the process whereby, the interest earned on an instrument, between the period that the interest is calculated over (known as accrued interest), is added to the principal sum so that the interest earned is also invested.

Question 2

Calculate the one month(31 days) continuously compounded zero coupon rate for Sterling with a discount factor of 0.996167. (Remember e=2.71828)

Answer 2

R = -LN (DF)/t
R = -Log(.996167, 2.71828)/(31/365)
R = 4.522%