How to Calculate Interest Rate Using Present & Future Value

When you are considering an investment, you want to know what rate of return an investment will give you. Some investments promise a fixed cost and a fixed payment at some point in the future. For example, a bond may cost $500 with the promise that $700 will be repaid 10 years in the future. Another bond may cost $600 with the promise that $900 will be repaid 15 years in the future. To determine which bond has a higher return, you need to determine the interest rate on the two investments.

Step 1

Use the formula below where "I" is the interest rate, "F" is the future value, "P" is the present value and "T" is the time.

I = (F / P) ^ (1 / T) - 1

Step 2

Divide the future value by the present value. For example, if an investment would cost $100 today and would be worth $120 five years in the future, you would divide $120 by $100 and get 1.2.

Step 3

Raise the number your calculated in Step 1 to the 1 divided by the number of years between the current value and the present value. For example, if the future value was predicted for 5 years in the future, you would raise the 1/5 power. Continuing the example, you would raise 1.2 to the 1/5 power and get 1.037.

Step 4

Subtract 1 from the number calculated in Step 2 to get the interest rate. For example, you would subtract 1 from 1.037 to find that the annual interest rate is 0.037, or 3.7 percent.

Warning

The interest rate is not the only factor to consider when comparing investments. A bond that has a higher interest rate likely has a higher risk of defaulting.

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