Business SENIOR

HIGH
Finance SCHOOL

Self-Learning
Module
Stated Rate and Effective Rate
16
Quarter 3
Business Finance - 12
Quarter 3 – Module 16: Stated Rate and Effective Rate
First Edition, 2020

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Business SENIOR
HIGH

Finance SCHOOL

Self-Learning
Module

16
Quarter 3

Stated Rate and Effective

Rate
Introductory Message

For the Facilitator:

Welcome to the Business Finance Self-Learning Module on Stated rate and

Effective rate!

This Self-Learning Module was collaboratively designed, developed and

reviewed by educators from the Schools Division Office of Pasig City headed by its
Officer-in-Charge Schools Division Superintendent, Ma. Evalou Concepcion A.
Agustin, in partnership with the City Government of Pasig through its mayor,
Honorable Victor Ma. Regis N. Sotto. The writers utilized the standards set by the K
to 12 Curriculum using the Most Essential Learning Competencies (MELC) in
developing this instructional resource.

This learning material hopes to engage the learners in guided and independent
learning activities at their own pace and time. Further, this also aims to help learners
acquire the needed 21st century skills especially the 5 Cs, namely: Communication,
Collaboration, Creativity, Critical Thinking, and Character while taking into
consideration their needs and circumstances.

In addition to the material in the main text, you will also see this box in the
body of the module:

Notes to the Teacher

This contains helpful tips or strategies that
will help you in guiding the learners.

As a facilitator you are expected to orient the learners on how to use this
module. You also need to keep track of the learners' progress while allowing them to
manage their own learning. Moreover, you are expected to encourage and assist the
learners as they do the tasks included in the module.
 For the Learner:

Welcome to the Business Finance Self-Learning Module on Stated rate and

Effective rate!

This module was designed to provide you with fun and meaningful
opportunities for guided and independent learning at your own pace and time. You
will be enabled to process the contents of the learning material while being an active
learner.

This module has the following parts and corresponding icons:

Expectation - This points to the set of knowledge and skills that

you will learn after completing the module.

Pretest - This measures your prior knowledge about the lesson

at hand.

Recap - This part of the module provides a review of concepts

and skills that you already know about a previous lesson.

Lesson - This section discusses the topic in the module.

Activities - This is a set of activities that you need to perform.

Wrap-Up - This section summarizes the concepts and

application of the lesson.

Valuing - This part integrates a desirable moral value in the

lesson.

Posttest - This measures how much you have learned from the
entire module.
 EXPECTATIONS

At the end of the lesson, you are expected to:

1. define stated and effective rates and;
2. compute the present value principal of loan with a stated rate not equal
to effective rate.

PRETEST

DIRECTIONS: On the space provided, write TRUE if the idea being expressed is
correct and FALSE if otherwise.

_________ 1. In most loan amortization schedules, amortization of discount or

premium of the loan increase over time.

_________ 2. The process of obtaining future values is called discounting.

_________ 3. A discount would occur if the stated rate is less than the effective rate.

_________ 4. A decrease in the discount rate would increase the present value.

_________ 5. A premium would occur if the stated rate of a loan is lower than the
effective rate.

RECAP

We have learned, to identify loan amortization and application of loan

computation.
 LESSON

STATED RATE / EFFECTIVE RATE

STATED RATE - annual interest rate provided for in the loan agreement (also the rate
to be paid by the debtor)

EFFECTIVE RATE – the annual interest rate that is being used in the market for a
similar loan (also called yield rate and discount rate)

In general, the stated rate and effective rate are usually the same. However,
there are times that these are not the same. The effect of the difference in rates is an
adjustment in the amount that you would receive initially. The amount that you will
receive would be equal to the present value of all future cash flows. The following
example shall illustrate this concept.
You are applying for a loan with a principal of ₱100,000 to be paid after 5
years to purchase a piece of equipment. You negotiated for a stated rate of the loan
of 6% which is lower than the current market rate of 10%. Let us compute for the
proceeds to be received from the bank:

Cash Flow Present Value Factor Present Value

Table (10%)
Principal 10,000 0.6209 (rounded) 62,090
Interest per year
(100,000 principal x
6% stated rate)
Interest – 1st year 6,000 0.9091 (rounded) 5,455
Interest – 2nd year 6,000 0.8264 (rounded) 4,958
Interest – 3rd year 6,000 0.7513 (rounded) 4,508
Interest – 4th year 6,000 0.6830 (rounded) 4,098
Interest – 5th year 6,000 0.6209 (rounded) 3,725
TOTAL 84,834

Take note that all present values in the table are rounded off to the nearest
peso. An alternative way to compute the proceeds (present value) is to use the present
value factor of ordinary annuity for the interest because it is constant at ₱6,000 per
year while using the present value factor for lump-sum for the principal. The solution
would be:
PV of principal = 100,000 x (1+0.10)-5
PV of principal = 100,000 x 0.6209 (rounded)
PV of principal = 62,090 (rounded)
 -5
PV of interest = 6,000 x 1-(1+0.10)
0.10
PV of interest = 6,000 x 3.7908 (rounded)
PV of interest = 22,745 (rounded)
0.10
Total PV = 84,835 (rounded)

Because of the lower stated rate, you would receive an amount lower than
₱100,000 which is the present value of ₱84,835. The difference is called a discount
which in effect a pre-payment of the 4% interest due to the lower effective rate.
The loan is amortized throughout the term of the loan through the use of a
loan amortization table as shown below:

A. Unpaid B. Interest C. Interest D. E. Unpaid

PV, based on based on Amortization PV, Ending
Year beginning Effective Stated Rate (B - C) (A + D)
Rate (principal x
(A x effective stated rate)
rate)
0
(date of the 84,835
loan)
1 84,835 8,484 6,000 2,484 87,319
2 87,319 8,732 6,000 2,732 90,051
3 90,051 9,005 6,000 3,005 93,056
4 93,056 9,306 6,000 3,306 96,362
5 96,362 9,636 6,000 3,636 99,998

Take note that all values in the loan amortization table are rounded off to the
nearest peso. Notice that the unpaid present value at the end of the loan term is
already equal to the principal of ₱100,000 (not considering the ₱2 difference due to
rounding off). Moreover, the unpaid PV at the end of each year is the market value of
the loan at the end of each year. Next, let us assume that interest is payable semi-
annually. How would the computation change? We simply compute the PV of both
principal and interest as follows:
PV of principal = 100,000 x (1+0.05)-10
PV of principal = 100,000 x 0.6139 (rounded)
PV of principal = 61,390 (rounded)
-10
PV of interest = 3,000 x 1-(1+0.05)
0.05
PV of interest = 3,000 x 7.7217 (rounded)
PV of interest = 23,165 (rounded)
Total PV = 84,555 0.10

Notice that the effective rate used in computing the present value is 5% (10%
divided by 2) while the interest payment is now equal to ₱3,000 which is computed by
multiplying the principal of ₱100,000 by half of the stated rate of 3%. The loan
amortization prepared for the semi-annual interest periods is shown as follows:

A. Unpaid B. Interest C. Interest D. E. Unpaid

PV, based on based on Amortization PV, Ending
Period beginning Effective Stated Rate (B - C) (A + D)
Rate (principal x
(A x effective stated rate)
rate)
0
(date of the 84,555
loan)
1 84,555 4,228 3,000 1,228 85,783
2 85,783 4,289 3,000 1,289 87,072
3 87,072 4,354 3,000 1,354 88,426
4 88,426 4,421 3,000 1,421 89,847
5 89,847 4,492 3,000 1,492 91,339
6 91,339 4,567 3,000 1,567 92,906
7 92,906 4,645 3,000 1,645 94,551
8 94,551 4,728 3,000 1,728 96,279
9 96,279 4,814 3,000 1,814 98,093
10 98,093 4,905 3,000 1,905 99,998

All figures in the table are rounded off to the nearest peso. Notice again that
the ending unpaid PV at the end of the loan term is equal to ₱100,000 (note that the
difference is caused by rounding off). The concept of quarterly interest payments as
well as monthly interest payments would be using a solution very similar to the
solution shown in this chapter.
The example provided above is a discount example. A discount would occur if
the stated rate is less than the effective rate. On the other hand, if the stated rate is
greater than the effective rate, we would have a premium. Assuming that our loan of
₱100,000 has a stated rate of 12% even if the current effective rate is 10%. Interest
is payable annually. The computation for the present value is as follows:
PV of principal = 100,000 x (1+0.05)-5
PV of principal = 100,000 x 0.6209 (rounded)
PV of principal = 62,090 (rounded)

PV of interest = 12,000 x 1-(1+0.05)-5

0.10
PV of interest = 12,000 x 3.7908 (rounded)
PV of interest = 45,490 (rounded)
Total PV = 107,580 0.10
 A. Unpaid B. Interest C. Interest D. E. Unpaid
PV, based on based on Amortization PV, Ending
Year beginning Effective Stated Rate (B - C) (A + D)
Rate (principal x
(A x effective stated rate)
rate)
0
(date of the 107,580
loan)
1 107,580 10,758 12,000 -1,242 106,338
2 87,319 10,634 12,000 -1,366 104,972
3 90,051 10,497 12,000 -1,503 103,469
4 93,056 10,347 12,000 -1,653 101,816
5 96,362 10,182 12,000 -1,818 99,998

You can see that the procedure for amortizing a premium is the same as the
procedure for amortizing a discount. Also note that regardless if there is a premium
or a discount, the unpaid balance at the end of the term is equal to the principal of
the loan (if principal payment is in lump-sum).

ACTIVITIES

Problem Solving. Analyze and show your computation in a sheet of paper.

On January 1, 2015, Mac Inc. issued 3,000,000 bonds with a coupon rate of
8% maturing in 4 years. The interest is paid annually, and the market interest rate
at the date of issue was 11%. What is the issue price of the bond? Prepare the 4-year
amortization schedule for the bond.
 WRAP-UP

• Differentiate Stated to Effective Rate.

• When is the premium rate occur?
• What is the difference between stated to effective rate?

VALUING

• When would there be a discount on a loan? How about a premium?

• Do you agree, that if there is a premium or a discount, the unpaid
balance at the end of the term is equal to the principal of the loan?
• How would you compare the stated to effective rate?
 POSTTEST

DIRECTIONS. Read the questions and encircle your answer.

1. What is the present value of a 3-year annuity of ₱100 if the discount rate is
6%?
A. 265.25 B. 267.30
C. 266.30 D. 268.40

2. Mr. Cruz has a ₱100,000 bond with a stated rate of 10% and an effective rate of
12%, which pays interest semi-annually and has a maturity of 3 years. At what
price should the bond be issued?
A. 95,182.00 B. 95,000.00
C. 95,232.67 D. 95,082.67

3. What is the present value of a 5-year annuity payment of ₱1,000 with a discount
rate of 5% if the first payment will be made today?
A. 4,122.87 B. 4,123.85
C. 4,000.00 D. 4,124.87

4. Mr. Reyes has a ₱100,000 bond with a stated rate of 10% and an effective rate of
8%, which pays interest semi-annually and has a maturity of 3 years. At what
price should the bond be issued?
A. 105,200.25 B. 105,250.15
C. 105,242.14 D. 106,000.00

5. Mr. Garcia invested in a ₱1,000 bond for one year with a coupon rate of 7% and
was offered at an effective rate of 5%. How much should he pay upfront?
A. 1,019.05 B. 1,019.10
C. 1,021.02 D. 1,018.05
Business Finance Teachers Guide
Vibal Group Inc.
(2017). Business Finance. Areneta Ave., Cubao, Quezon City, Philippines:
Tugaz, Florenz C.; Dela Cruz, Aeson Luiz C.; Paril, Joshua S.; and Tang, Alger C.
Enterprise & Co. Inc.
Domingo, James Cristopher D. (2013). Business Finance. Manila, Philippines: GIC
Mandaluyong City, Philippines: Anvil Publishing, Inc.
Alminar-Mutya, Ruby F. (2018). Business Finance: A Management Approach.
REFERENCES
Activity
Issue price: PHP2,720,779.89
Principal 1,976,192.92
Interest 744,586.97
2,720,779.89
period Interest to be Interest expense Amortization of Carrying
paid = 3M x 8% carrying amt. x 11% discount balance
= int. exp. – int. paid
2,720,779.89
1 240,000 299,285.79 59,285.79 2,780,065.68
2 240,000 305,807.22 65,807.22 2,845,872.90
3 240,000 313,046.02 73,046.02 2,918,918.92
4 240,000 321,081.08 81,081.08 3,000,000.00
PostTest Pretest
1. FALSE
1. B
2. FALSE
2. D
3. TRUE
3. A
4. FALSE
4. C
5. FALSE
5. A
KEY TO CORRECTION