Bank Discount: In many bank loans, the interest charge computed not on the amount

borrower receives but on the amount that is repaid later. In case of bank discount future
value is called maturity value, present value is called proceed and interest rate is called
discount rate (d).
So, in case of bank discount, Interest (I)= Fdn

We know, F= P+ I
F= P+ Fdn
P= F- Fdn
P= F (1-dn)

d
Effective interest rate, ie =
1 − dn
Note that, effective interest rate (ie) and interest rate (i) are same.

Example: Fran sings a note promising to pay a bank $12000 ten months from now and
receives $10000. Find the discount rate and effective interest rate.
Solution:
Here, F = 12,000
P = 10,000
d =?
n= 10 months = 10/12 = 0.8333

We know, P = F (1- dn)

 10000 = 12000 {1-(d×0.8333)}
10000
 (1-0.8333d) =
12000
 1-0.8333d = 0.8333

 -0.8333d = 0.8333 - 1

 -0.8333d = -0.1666
  d = 0.1666/0.8333

 d = 0.1999 × 100

 d = 19.99%

Again, d = 19.99% = 19.99/100 = 0.1999

n= 10 months = 10/12 = 0.8333
d
we know, Effective interest rate, ie =
1 − dn
ie = 0.1999/ (1- 0.1999×0.8333)
= 0.1999/ (1- 0.1665)
= 0.1995/ 0.8334
= 0.2393×100
= 23.93%

Home Work:
Page: 399 - 400: Problem Set 6 -1: 1 - 12, 14 - 29

Compound Interest: Compound interest is the addition of interest to the principal sum of
a deposit, or in other words, interest on interest. Compound interest can be calculated in
five different terms: annually, semi-annually, quarterly, monthly and daily.
Now, we find out the formula for calculating the future value if the interest rate is
compounded
Annually F = P (1 + i)
n
1)
2n
 i
2) Semi-annually F = P 1 + 
 2
4n
 i
3) Quarterly F = P 1 + 
 4
12 n
 i 
4) Monthly F = P 1 + 
 12 
 n
 i 
5) Daily F = P 1 +  where, n in days.
 365 

Example: Compute the Future value if $70,000 is invested for 5 years at 9%

compounded annually.
Solution:
Here, P= 70,000
i= 9% = 9/100 = 0.09
n= 5 years
F=?
Since the interest rate is compounded annually, then
Future value, F = P (1 + i)n
= 70000 (1 + 0.09)5
= 107703.6768

Interest, I= F – P = 37703.6768

If we compute the future value using the rest of the interest rates then we have,

2) Compounded semi-annually then,

2n
i
Future value, F = P 1 + 
 2
25
 0.09 
= 700001 + 
 2 
10
 0.09 
= 700001 + 
 2 
= 108707.8595

Interest, I= F – P = 38707.8595

3) Compounded quarterly then,

4n
i
Future value, F = P 1 + 
 4
45
 0.09 
= 700001 + 
 4 
20
 0.09 
= 700001 +  = 109235.644
 4 
 Interest, I= F – P = 39235.6440

4) Compounded monthly then,

12 n
i
Future value, F = P 1 + 
 12 
125
 0.09 
= 700001 + 
 12 
60
 0.09 
= 70000 1 + 
 12 
= 109597.6719

Interest, I= F – P = 39597.6718

5) Compounded daily then,

n
i 
Future value, F = P 1 +  here, n in days = 5×365 = 1825
 365 
1825
 0.09 
= 70000 1 + 
 365 
1825
 0.09 
= 70000 1 + 
 365 
= 109775.7635

Interest, I= F – P = 39775. 7635