Question

What is the concept of time aggregation used in Finance?

Answer 1

Let us first understand the meaning of aggregation.

Aggregation means formation or collection of number things into cluster.

Continuous Compounding refers to a method in which the principal amount is compounded at every moment till infinity. The amount of interest collected is formed as cluster at every moment and interest is earned on this amount and the principal amount at every moment.

The formula for continuous compounding is e^rt where r = rate of interest and t = total time in years.

One of the most important advantage of continuous compounding is the amount is aggregated over the time and this aggregated amount earns interest to perpetuity. Therefore, the Effective Annual Rate of continuously compounded rate is more than the EAR of other frequency i.e. monthly, quarterly etc. and hence, the continous compounding is the most preferable.