Mathematics Of Finance
GERLYN P. ORDONIO
INTRUCTOR
Presented by:
Ms. Gerlyn P. Ordonio
What is Interest?
What is Interest?
This extra amount is called the “INTEREST”
The original amount borrowed is known as
the “PRINCIPAL” or “CAPITAL” in different
situations.
The sum of both Principal and the interest is
known as “AMOUNT”
Types of Interest:
Interest
Interest is the money that is paid for use of money.
Simple Interest
Compound Interest
Simple Interest
Interest paid on the principal only and NOT
on any accumulated interest.
Simple Interest Formula
I=P.i.n or
I= P.R.N where:
I= interest
P= Present
value/Principal
r or i= Rate of Interest
t or n= Time in Years
1,000 is invested at two years in a bank, earning a simple interest rate of 8% per
annum. Determine the simple interest earned….
P=1000
I=Prt
r=8%=0.08 =1000*0.08*2
t=2
=160
10, 000/- is invested for 4 years 9 months in a bank earning a simple interest rate of
10% per annum. Calculate the simple amount at the end of the investment period.
We know that future value of simple interest is
Future value= present value + interest
Given that; P=10,000 F=P(1+i.n)
i=10%=0.10
n=4 years 9 month =10,000(1+0.1*4.75)
=4*9/12=4.75 =14,750
What is “Compound
Interest”
Compound interest is interest calculated on the initial principal and also on
the accumulated interest of previous periods of a deposit or loan.
Compound interest can be thought of as “interest on interest,”
Compound interest make a deposit or loan grow at a faster rate than simple
interest.
Difference Between Simple Interest and Compound Interest
Simple Interest Compound Interest
This is calculated only on the original This is calculated on the interest earned
principal and the principal amount.
Interest earned is not reinvested. Interest earned during the previous period
Therefore, it is not used in interest is added to the principal.
calculations for following periods.
Simple interest is normally used for short- For long-term loans, compound interest is
term loans of 30 or 60 days. used.
Compound interest terms used in formula
Terms Symbols
Total Amount …………………….. ……………………………………A
Original principal ………………………………………………….. P
Nominal interest rate ( per year) ……………………………………. r
Frequency of conversions……………………………………………. m
Periodic interest rate …………………………………………….. i = r/m
investment period/ term (years) …………………………….…………t
Number of conversion periods in the investment ……………… .... n =m*t
COMPOUND INTEREST
Suppose, 9,000 is invested for seven years at 12% compounded
quarterly
P 9000
r 12% interest calculated 4 times a year
m 4
t 7
r 12%
i 3%
m 4
n mt 47 28
COMPOUND INTEREST
n mt
S P 1 i
n
r
i
m
1. A nominal rate is interest that is calculated more than once a year.
2. An effective rate is the actual rate that is earned in a year. It can also be defined as
the simple interest that would produced the same accumulated amount in 1 year as the
nominal rate compounded m times a year.
The formula to calculate the effective rate of interest
is given by
m
r
reff 1 1
m
Determine the effective rate of interest corresponding to
a nominal rate of 8% per year compounded
I. annually
II. semi – annually
r 8%; m 1; r 8%; m 2;
reff 1 0.08 1 0.08
2
0.08
1 1.04 1 0.0816
2
reff 1
2
Annuity – Definition
Annuity is a series of equal payments made at equal
intervals of time.
Examples of annuity:
• Shop rentals
• Insurance policy premium
• Regular deposits to saving accounts
• Installment payments
Annuity can be classified into 2 classes:
1. Annuity certain/ ordinary annuity – payment are made at the end of
each payment period.
2. Annuity due – payment are made at the beginning of each period.
Future & Present values Ordinary Annuity Certain
future value of Ordinary
Annuity
n mt
1 i 1
n
S R
i
r
i
m
n mt
1 1 i n
A R
i
r
i
m
SINKING FUND
Sinking fund is an account that is set up for a specific purpose at some future date.
For example:
1. An individual might establish a sinking fund for the purpose of discharging a debt
at a future date.
2. A company might establish a sinking fund in order to accumulate the sufficient
capital to replace equipment that is expected to obsolete at some future date.
THANK
YOU
