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Interest on Term Deposit accounts

Discussion in 'Business, Investment and Economics' started by tom82, May 7, 2014.

  1. tom82

    tom82

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    How do banks calculate interest on term deposits, what is the formula for this?
    What I thought was the calculation didn't seem to equal what the bank calculator on website said so want to know how to calculate it myself.
    Thank you
     
  2. pixel

    pixel DIY Trader

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    Like everything else, the term deposit rates are determined by supply and demand.
    If a Bank has a particular investment project, for which $xxx is needed short-term, they may offer a premium to the RBA cash rate. For other terms they may simply leave the rate at RBA cash and bank the difference (to, for example, business loans or mortgages) as their profit.
    On a site such as http://www.ratecity.com.au/term-deposits/ you will notice some small differences. Whenever I find a TD mature and ready to be rolled over, I don't check any hypothetical calculators, but simply check Ratecity or the banks' website; then I'll pick the best current offer and term.

    Not unlike Coles and Woolworths really: One may sell today's bananas a few cents cheaper, next week it's the other way around. But you won't find any rhyme or reason WHY.

    Once you've settled on a term and amount, the calculation is simple: Most banks will use the formula "Principal times daily interest rate times number of days". Differences between their and your calculation should only occur after the decimal point. If memory serves me correctly, Banks use 360 days per year; the number of decimals they apply in their algorithm and the direction they round up or down may also differ from yours. And that would give slightly different results. Hardly worth arguing about - unless you do find a discrepancy significant enough to ask ... :1zhelp:
     
  3. tom82

    tom82

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    I'm not sure you understood the question. Lets see if I can word it a different way.
    What is the formula used to calculate interest on a term deposit account?

    Thank you
     
  4. pixel

    pixel DIY Trader

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    sorry Tom,

    I accidentally sent the first part off before I had completed the reply :)
     
  5. tom82

    tom82

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    Ok, no worries, what was the second part?
     
  6. DJG

    DJG

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    Do you want simple or compound interest?
     
  7. tom82

    tom82

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    Which do banks use?

    How about both?
    Both would be good to know.

    Thanks
     
  8. McLovin

    McLovin

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  9. tom82

    tom82

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    Ok, thank you.

    So to clarify, the formula is?

    A = P * (1 + r/n) * n * t

    Where / how do you find out how often they calculate the interest, haven't seen anything on bank sites stating how often they do that?
     
  10. McLovin

    McLovin

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    No it's ^nt.

    All the info should be in the t&c's, product disclosure statement etc.
     
  11. tom82

    tom82

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    ^ ?
     
  12. McLovin

    McLovin

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    To the power of.
     
  13. tom82

    tom82

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    Thanks for the reply.

    To help me understand this better would you be able to show me an example of how to do this calculation?

    Thanks
     
  14. McLovin

    McLovin

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    Sure

    For simplicity's sake assume interest is paid annually.

    Interest rate (r) = 10%
    Time (t) = 5 years
    Principal (P) = $100

    A=P(1+r)^t
    A= $100(1+0.1)^5
    A= $161.051

    If interest was being paid quarterly then you'd adjust...

    Interest rate (r) = 10%
    Time (t) = 5 years
    Principal (P) = $100
    Number of compounding periods/year (n) = 4

    A=P(1+(r/n))^nt
    A=$100(1+(0.1/4))^4*5
    A= $163.86
     
  15. tom82

    tom82

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    I did the calculation and got 1.61051.

    If the time was less than a year say 90 days or 180 or some such would you replace 5 with the number of days?
    Do you need to tell the calculation how often the interest is calculated in the time?
     
  16. McLovin

    McLovin

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    Multiply by $100

    No. The exponential (ie the ^nt) bit is the number of times in total over the period that your money compounds. Basically, the interest rate needs to match the compounding period. So if you're compounding twice/year then (i) becomes 5%/period and the periods go from 5 to 10. See my second example above...
     
  17. tom82

    tom82

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    So if a bank says they calculate the interest every day of the term do mean they are compounding it everyday, is it the same thing?
     
  18. tom82

    tom82

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    That second example I got 5.51.
     
  19. McLovin

    McLovin

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    It means if you put money in, it will start earning interest that day. But the bank will only pay interest monthly or quarterly. And compounding in this sense means earning interest on interest. I suppose you could knock up a spreadsheet that will do it all for you otherwise it's going to be very tedious, especially if you have a lot of txns going through.
     
  20. tom82

    tom82

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    Ok, I get that if you put money in it starts earning interest the same day. Yes, I have seen monthly, quarterly and at maturity.
    So does that mean they only compound on the day they pay the interest?
     
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