Measures of Interests

Interest
In the world of business, an investor who
places capital in a productive enterprise expects
not only the eventual return of his capital, but
also additional payment.
An individual who lends his capital expects
the debtor to pay back not only the money
originally borrowed but also additional amount.
This additional payment is called interest.
Simple Interest
I= Prt
I= simple interest
P= principal
r = interest rate per period of time
t= time (in years)
 There are times when
money is borrowed for a certain
number of days only. If the
number is placed over 12, the
number of days is placed over
360 or 365 days.
 Ordinary Simple Exact Simple Interest
Interest
𝐷 𝐷
𝐼0 = 𝑃𝑟 𝐼𝑒 = 𝑃𝑟
360 365
𝐼0 = ordinary simple 𝑒 = ordinary simple
interest interest
P= principal P= principal
r = interest rate per r = interest rate per
period of time period of time
D= number of days D= number of days
 Example
• Find the ordinary and exact simple interest on
P15,000 if it is invested at 12% for 60 days.
Ans: 𝐼𝑜 = 𝑃300 𝐼𝑒 = 𝑃295.89

• Find the maturity value of P4,250 at 9% for 90

days using exact interest method.
Ans: P 4,344.32
 Approximate and Exact Time
• Exact time: the exact number of days as found
in the calendar

• Approximate time: each month is assumed to

be 30 days.
 Example
On May 4, 2018, Mr. Fuentes borrowed P22,000
at 10% interest. Interest and principal were due
on September 6, 2018. What was the total
amount paid by him on that date using ordinary
simple interest?

Ans: Using approximate time-P22,745.56

Using exact time-P22,763.89
 Simple Discount
• Discount is a deduction from the maturity
amount of an obligation given by;
D=Fdt
Where:
D= discount
F=amount of maturity
d=discount rate
t=time or term of discount
 Example
Find the present value of P2,000 which is due at
the end of 90 days at 5% simple discount

ans: P1,975
Alternative solution: P=F(1-dt)
Present Value and Compound Discount
• The present value is defined as the principal P
which, if invested for the given time t at a given
interest rate r, will amount on F on the date that
F is due.
𝒋 𝒎𝒕
P=F(1+i)𝒏 P=F(1+ )
𝒎
• Compound Discount is the difference between
the final amount F and the present value P
D=F-P
 −𝒏 𝒋 −𝒎𝒕
P=F(1+i) P=F(1+ )
𝒎
Where:
F= expected amount at year n
P=present value
i= periodic rate (i=j/m)
n=total no. of conversion periods for
the whole term
D=compound discount
 Example
If money can be invested at 5.6% converted
quarterly, find the present value of P42,000 due at
the end of 3 years and 9 months.

Given: F=P42,000 j=0.056 m=4 t=3.75

𝑗 0.056
Solution: i = = = 0.014
𝑚 4
n=mt= (3.75)(4)=15
P=F(1+i)−𝒏 = 42,000(1+0.014)-15=34,094.16
0.014 −4∙3.75
Alt: P=42,000(1+ ) = 𝑃34,094.16
4
 Time and Rate
Time refers to the term of an investment or how long it
will take a certain amount of money to amount a certain
other sum if it is invested at a certain interest rate:
𝑛
t=
𝑚
the logarithmic method is used to find the n when the
interest rate is compounded:
𝐹
log
𝑃
n=
log(1+𝑖)
When the compounded and principal amounts are given
together with the time, the nominal rate and interest
rate per compounding period can be calculated using:
𝑛 𝐹
i= -1 ; j=im
𝑃
 Example
How long will it take P36,600 to amount to P40,000, if the
interest rate is 5% quarterly?
Given: P=P36,600 F=P40,000 j=0.05 m=4
Solution:
𝐹
𝑗 0.05 log 𝑃
i= = = 0.0125 ; n=
𝑚 4 log(1+𝑖)
40000
log
n= 36600 = 7.150820744
log(1 + 0.0125)

𝑛 7.150820744
t= = = 1.787705186 years or 1 year & 9 mos.
𝑚 4
 Rates
• Periodic Rate (i) is the rate used to compute
compound interest factors and it is equal to the
rate (r) divided by the conversion period (m).
• When the conversion period is other than a year
(semi-annually, quarterly, or monthly), the stated
annual rate of interest is called the Nominal Rate
(j)
• Effective Rate (e) is the actual earning in a year.
 Rates
• Formulas:
1
j= m (1 + 𝑒) − 1
𝑚

𝑗 𝑚
e= m (1 + ) −1
𝑚
Where:
e= effective rate
j= nominal rate
m= conversion period
 Example
What nominal rate compounded monthly will yield
1
the effective rate of 3 %?
2

Given: e=0.035
m=12
1
Solution: j= m (1 + 𝑒) − 1𝑚
1
=12 (1 + 0.035) − 1
12

=0.0345 or 3.45%
 Equivalent Rates
• If two rates, produce equal interests on the
same principal in the same period of time,
they are said to be corresponding or
equivalent rates.
• To determine the compound interest rate
equivalent to another compound interest:
𝑔 𝑚
eq= me (1 + )𝑚𝑒 −1
𝑚
 𝑚
𝑔
eq= me (1 + ) 𝑚𝑒 −1
𝑚
Where:
eq= the missing or unknown rate
me=the conversion period of the missing rate
g=the given interest rate
m=the conversion period of the given rate
To determine the simple interest rate equivalent
to compound interest rate, the formula is:
1+𝑖 𝑛 −1
r=
𝑡
where:
r= the missing or unknown simple interest rate
i= periodic rate
t=the term or the time of investment
n=the number of conversion periods for the
whole term
 Example
What rate compounded semi-annually is
equivalent to 5% compounded monthly?
Given: g= 0.05 me=2 m=12
Solution:
𝑔 𝑚 0.05 12
eq= me (1 + )𝑚𝑒 − 1 = 2 (1 + )2 −1
𝑚 12
=0.0505 or 5.05 %
 Varying Interests
When certain principal amount is
compounded at changing rates, that is,
the accumulation factors are different
interests rates for given specific
periods, the compound amount will be
equal to the product of the principal
and the several accumulation factors.
 Example:
A small private company invested Php 500,000
for 5 years. During the first 2 years, the interest
rate is 5% converted semi-annually and then 8%
compounded monthly for the remaining years. If
no withdrawals happened, how much will be the
compounded amount of the investment?
 Solution:
Since P=F(1+i)𝒏 𝑐𝑜𝑚𝑝𝑜𝑢𝑛𝑑 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡
Then: P=F(1+𝒊𝟏 )𝒏 (1+𝒊𝟐 )𝒏 … (1+𝒊𝒏 )𝒏 or
𝒋𝟏 𝒎 𝒕 𝒋𝟐 𝒎 𝒕 𝒋𝒏 𝒎 𝒕
P=F(1+ ) 𝟏 𝟏 (1+ ) 𝟐 𝟐 … (1+ ) 𝒏 𝒏
𝒎𝟏 𝒎𝟐 𝒎𝒏
𝟎.𝟎𝟓 𝟐(𝟐) 𝟎.𝟎𝟖 𝟏𝟐(𝟑)
P= 500,000(1+ ) (1+ )
𝟐 𝟏𝟐
P= 701,052.02
 Equation of Values
The value of an obligation on any date is
the sum of money which if possessed today is as
desirable as the payment promised in the
obligation. If the present values of two
obligations are the same, their values at any
future time must likewise be equal, because
these future values are the compound amounts
of the two equal present values.
 Equation of Values
Similarly, if the present values are equal,
the values at any previous date must have been
equal. Hence, any comparison date (cd) may be
used in comparing the values of two obligations
because if their values are equal on one date
they are equal on all other dates, both past and
future. Further, a value (obligation) greater than
another will be greater on all dates.
SUM of PAYMENTS=VALUE of OBLIGATION
 Example 1:
Denver have loans due of Php 8,000 in 4 years
and Php 9,600 in 6 years. If money is worth 10%
converted quarterly, calculate the single
payment during the 5th year that will settle his
obligation.
 Solution 1:
If the specified date is the comparison date: that is
year 5 is (cd) or (x)

x= 8,000 (1 + i)𝑛 + 9,600 (1 + i)−𝑛

.10 4(1) .10 −4 1
x= 8,000 (1 + ) + 9,600(1 + )
4 4
x= 17,527.63
 Solution 2:
If the comparison is set at year 0.

x (1 + i)−𝑛 = 8,000 (1 + i)−𝑛 + 9,600 (1 + i)−𝑛

.10 −4(5) .10 −4(4) .10 −4 6

x(1 + ) = 8,000 (1 + ) + 9,600(1 + )
4 4 4

x= 17,527.63
 Example 2
Ben deposits $8000 into an account paying 2.8%
(2) on his nephew’s 10th birthday. His nephew is
to receive 4 equal payments on his 20th, 21st,
22nd, and 23rd birthdays. How much is each
payment ?
Solution:
 Activity:
1. Accumulate P750,000 for 20 years if the
interest rate is 12% compounded semi-annually
for the first 10 years, 15% compounded monthly
for the next 5 years and 17% for the remaining
years. Find the compound amount at the end of
the 20 years.
 Activity:
2. Arlene wants to buy a sofa bed that costs Php
30,800 in an installment basis. She gave Php
10,800 as down payment and agrees to pay the
balance in three equal payments. These will be
held in 3, 6, and 9 months. If interest is charged
at 5 percent compounded monthly, what will be
the size of each payment.
 Activity
3. In an estate, $200000 is left to 3 heirs ages
10,12, and 16. The will stipulates that each is to
receive an equal amount in the year of his/her
21st birthday. If the money is invested at
4.8%(12) and the focal date is now, how much
does each receive?