1

I am newbie, so forgive me if my question seems trivial. I have a numerical where a bank scheme triples a person's investment in 5 years but it doesn't talk about the compounding frequency. Assuming it to be compounding yearly I get a CAGR of 24.57%.

I was wondering does the compounding period matter? Will I end up getting the effective yield per year as 24.57 % even for semi annual, quarterly or monthly compounding periods? I know there is a difference between nominal rate and effective rate. Is CAGR the effective rate which would stay the same irrespective of compounding period which would only change the nominal rate??

1

In your context, no, the compounding frequency does not matter. You are calculating the effective annual rate for a 200% return over 5 years, which would be:

   (1+r)^5 = 3
==>    1+r = 3 ^ 1/5
==>    1+r = 1.2457
==>      r = 24.57%

Where the compounding frequency will matter is when you calculate the nominal rate, meaning how much the investment grows in each period. For example, the monthly rate (annualized) would be:

 1.2457 ^ (1/12) - 1 = 1.847% (22.17% annualized)

For daily compounding it would be:

1.2457 ^ (1/365) - 1 = 0.06% (21.98% annualized)

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.