Teaching the Time Value of Money: Advantages of the Continuous Compounding (Exponential) Model

Abstract

It is vitally important that business students understand the conceptual meaning of the time value of money (TVM) and how to solve TVM related business problems. Most textbooks explain TVM using only discrete compounding. We argue that incorporating continuous (or exponential) compounding into the curriculum can be advantageous. The exponential model allows students to develop a better conceptual understanding of TVM problems. It allows instructors to visually demonstrate a number of important TVM concepts. And finally, the exponential model allows students to understand and solve problems from the natural world. Student reaction to the incorporation of continuous compounding into the curriculum is generally positive.