MATHEMATICS OF FINANCE

Interest
Interest is the cost for the use of money. When you deposit money in a bank, it will earn interest but when you
borrow money from a bank, you will pay interest.

The amount deposited in a bank or borrowed from a bank is called the principal, the percent used to determine the
amount of interest is called the interest rate, and the duration of the deposit or loan is called the time.

SIMPLE INTEREST
The interest paid on the original principal is called the simple interest (I), and the unit of time (t) is usually
expressed as annual interest rates. This means that we will assume the interest rate to be annual unless specified. When
the duration of the load is less than a year, the t shall have a value in fraction of a year. For example: a loan due in nine
9
months with an interest rate of 1.7% shall have a t value of 12. A daily/ monthly interest rate shall have a daily/ monthly
unit of time. For instance, a two- year loan of ₱2,500.00 bears an interest rate of 0.05% monthly. In this example, t shall
have a value of 24 since there are 24 months in 2 years.

I = Prt

Where:
I = simple interest
P = principal or original amount
r = rate of interest presented in problems in percent form (%) but is converted to decimal form by dividing the given by
100 when substituted to the formula
t= time

Example 1:
You have deposited ₱5,000.00 in a Savings Bank on January 1, 2016 with an interest rate of 3% and have
withdrawn in on January 1, 2017. Calculate the simple interest.

Solution:

Given:
P = ₱5,000.00
3
r = 3% = = 0.03
100
t = January 1, 2016- January 1, 2017 = 1 year

Required: I

Solution:

I = Prt = (₱5,000.00) (0.03) (1) = ₱150.00

Example 2:
A loan of ₱3,000.00 bears an interest rate of 2% per month. If the loan shall be paid in four months, how
much is the interest?

Given:
P = ₱3,000.00
2
r = 2% per month = 100 = 0.02
t = 4 months

Required: I

Solution:
I = Prt = (₱3,000.00) (0.02) (4) = ₱240.00
 The time shall be measured in the same period as the interest rate. Now if the interest rate is annual and the time
is days, we need to express the time as a fractional part of a year. We can use either the exact method or the ordinary
method.

For exact method:

Month Number of days during leap year Number of days during non- leap year
January 31 31
February 29 29
March 31 31
April 30 30
May 31 31
June 30 30
July 31 31
August 31 31
September 30 30
October 31 31
November 30 30
December 31 31
Total 366 days 365 days

For ordinary

Month Number of days

January 30
February 30
March 30
April 30
May 30
June 30
July 30
August 30
September 30
October 30
November 30
December 30
Total 360 days

𝑒𝑥𝑎𝑐𝑡 𝑛𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑑𝑎𝑦𝑠

The banker’s rules ( 360
) is used when the problem does not indicate what method will be used.
Example:
Calculate the simple interest due on a 72- day loan of ₱3,000.00 if the annual interest rate is 4%.

Given:
72
t = 72 days = 360
P = ₱3,000.00
4
r = 4% = = 0.04
100

Required: I

Solution:
72
I = Prt = (₱3,000.00) (0.04) (360) = (₱3,000.00) (0.04) (0.2) = ₱24.00

In case the unknown is the principal or the original amount (P), or the rate (r), or the time:

When the principal (P) is the unknown or required:

From: I = Prt
𝐼 𝑃𝑟𝑡
𝑟𝑡
= 𝑟𝑡

𝐼
P=
𝑟𝑡
When the rate of interest (r) is the unknown or required:
From: I = Prt
𝐼 𝑃𝑟𝑡
=
𝑃𝑡 𝑃𝑡

𝐼
r = 𝑃𝑡 (100) = ___ %

When the time (t) is the unknown or required:

From: I = Prt
𝐼 𝑃𝑟𝑡
=
𝑃𝑟 𝑃𝑟

𝐼
t = 𝑃𝑟 = ___ year/s

Example 3:
The interest charged on a 10- month loan of ₱6,000.00 is ₱200.00. Find the simple interest rate.

Given:
10
t = 10 months = 12
P = ₱6,000.00
I = ₱200.00

Required: r

Solution:
𝐼 ₱200.00 200
r = 𝑃𝑡 (100) = 10 (100) = 5000 (100) = 0.04 (100) = 4 %
(₱6,000.00)( )
12

Maturity or Future Value (F)

The maturity or future value (F) is the sum of the principal and the interest.

F=P+I

From the formula of Simple Interest:

I = Prt

F = P + Prt
F = P (1 + rt)

Example 4:
A cooperative released a ₱9,000.00 emergency loan to Ana with a simple interest of 4.5%. If she intends to pay it
in 2 years, what amount will she pay back to the cooperative?

Given:
P = ₱9,000.00
4.5
r = 4.5% = 100 = 0.045
t = 2 years

Required: F

Solution:

F = P (1 + rt) = ₱9,000.00 [1 + (0.045) (2)] = 9,000 (1+ 0.09) = 9,000 (1.09) = ₱9,810.00
Present Value (S)
The interest on loans may be deducted in advance from the principal amount, so if a borrower applies for a loan of
₱10,000.00, he will receive an amount of less than ₱10,000.00 since the interest is deducted from the principal loan before
it is released to him the borrower.

S=P–I

From the formula of Simple Interest:

I = Prt

S = P – Prt
S = P (1 – rt)

Example 5:
Ana needs ₱25,000.00 now to buy a laptop. She has decided to borrow money from a lending company that charges
8% simple interest deducted in advance? How much loan will Ana apply if she pays it in 2 years?

Given:
S = ₱25,000.00
8
r = 8% = = 0.08
100
t = 2 years

Required: P

Solution:

From the formula of present value:

S = P (1 – rt)

𝑆 𝑃 (1−𝑟𝑡)
=
(1−𝑟𝑡) (1−𝑟𝑡)

𝑺
P=
(𝟏−𝒓𝒕)

𝑆 25,000 25,000 25,000

P = (1−𝑟𝑡) = [1−(0.08)(2)] = (1−0.16) = 0.84
= ₱29, 761.90

Therefore, Ana should apply for a loan of ₱29,761.90 for her to receive ₱25,000.00 which she needs to buy for a laptop.