BT11803: MATHEMATICAL ECONOMICS TUTORIAL

TUTORIAL 4 – Mathematics of Finance

Question 1
COMPOUND INTEREST
a. What is the formula for Compound Interest and state the benefit of a negative interest
rate.

ANSWER
S=P (1+ r )n

or

( )
nt
r
A=P 1+
n

S or A = Future value/Total Amount; P= Principal/Initial Amount; r = Annual Interest Rate

(in decimal); n = Amount of times interest is compounded per time period; t = Time period
(usually in years)

If a central bank implements negative rates, that means interest rates fall below
0%. In theory, negative rates would boost the economy by encouraging
consumers and banks to take more risk through borrowing and lending money.

b. Majestic Chuby invested £250 in a cat’s building society account. At the end of the year
her account is credited with 2% interest. How much interest had her £250 earned in the
year?

ANSWER

Interest=2% of £ 250
2
¿ × £ 250=£ 5
100

1
c. Empress Chuya borrow £ 500 for four years and agree to pay back 6 % compound
2
interest for this period annually. What amount will she has to pay back?

ANSWER
S=P (1+ r )n

( )
4
6.5
¿(500) 1+
100
¿ 643.233
Question 2
PRESENT VALUE AND FUTURE VALUE
a. What is the formula for Present Value?
P=S (1+ r )−n
or
1
PV =FV n
(1+ r)

b. $6000 due in 20 years at 5% compounded annually. Find the present value of the given
future payment at the specified interest rate.
ANSWER

( )
−20
5
P= (6000 ) 1+ =$ 2261.34
100

c. Find the present value for $3500 due in eight years at 6% effective.
ANSWER

( )
−8
6
P= (3500 ) 1+ =$ 2195.94
100

d. A debt of $7000 due in five years is to be repaired by a payment of $3000 now and a
second payment at the end of five years. How much should the second payment be if
the interest is 8% compounded monthly?
ANSWER

Use compound interest formula first

( )
nt
r
A=P 1+
n

Let x be the payment at the end of 5 years. The equation of value at year 5 is

( )
5 ( 12 )
8
100
7000= ( 3000 ) 1+ +x
12

( )
60
0.8
x=7000−( 3000 ) 1+
12
x=$ 2530.46
Question 3
ANNUITIES
Supposed you invest in an IRA by depositing $2000 at the end of eery tax year for the next
year for the next 15 years. If the interest rate is 5.7% compounded annually, how much will
you have at the end of 15 years?
ANSWER
Let R=2000 and let r =0.057 . Then, the value of the IRA at the end of 15 years,
when n=15, is given by (using the present value of an annuity formula)

S=R ( (1+r )n−1

r )
S= ( 2000 ) ( (1+ 0.057 )15−1
0.057 )
=45,502.06

Thus, at the end of 15 years the IRA will be worth $45,502.06 .

QUESTION 4
AMORTIZATION OF LOANS AND PERPETUITIES
Determine the finance charge for a 48-month auto loan of $11,000 with monthly payment at
the rate of 5.5% compounded monthly.

ANSWER
From the formula

Or in a simpler form

PV = ( Pmti )
Where Pmt is the periodic payment and i is the discount rate