Professional Documents
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Overview
This unit introduces you to the basics of financial literacy and outlines some of the fundamental ideas of
budgeting, saving, and investing. It will also give you an in-depth detail on how basic mathematics is deeply anchored with
much of the discussions in finance and economics through different formulas.
Learning Objectives:
Setting Up (Unit 8)
Say you have a spare amount of money amounting to Php 100000, how are you going to spend it? Why?
Lesson Proper
Many of you have already encountered this statement: money makes the world go round. This merely expresses
that money is one of the many important things in life since the financial system that is currently in place puts an emphasis
on its use to establish and keep economic activities up and going.
In the realm of finance and economics, money is seen to have four primary functions (Prince Michael of
Liechtenstein, 2014; Ponnusamy, 2016; Lumen Learning, n.d.; Houghton Mifflin Harcourt, n.d.):
a. As medium/means of exchange
We utilize money for the facilitation of transactions, for buying and selling goods and services. Before
money was created and our current set-up for trading was institutionalized, the standard practice was to perform
direct exchange of goods and/or services. This system is called barter trading and it is still done today. Modern
day barter trading is largely seen and done online (e.g. swapping of items in Facebook marketplace, acquisition or
exchange of rare items through a swap feature in an online-based game). This kind of system proved to be
problematic since a buyer can only engage in a trade if the supplier possesses the buyer’s desired good or
service and vice versa.
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c. Store of value
One’s wealth can be stored in many forms such as in acquisition of land, collection of artworks or toys,
and investments in jewelry and business(es) to name a few. Through these, you can be able to preserve the
value of your money. But, most people find it convenient to simply have that value stored as cash either held on
hand or deposited in the bank because money kept as such has a high degree of liquidity (in finance and
economics, liquidity means the ability of an asset to be quickly turned into cash) unlike those mentioned, you still
need to put them on sale in order to obtain cash. Apart from this, cash can be easily transported because one can
simply convert it from one currency to another and is readily accepted anywhere; however, it should be noted that
keeping your money as cash may not be the most practical form of wealth storage if one is concerned of its
purchasing power - the amount/volume of goods and/or services that can be bought on a per unit currency basis -
because whether you like it or not, its value might decrease through time as affected mainly by inflation.
Knowing the purposes behind the existence of money is one step in fully understanding how our financial system
works and eventually the extent of your financial literacy - the ability of an individual to manage his/her financial resources
efficiently and effectively. Many, especially financial educators, find that financial literacy is one of the core life skills that
must be developed at an early age because an ignorance to this may lead you to poor financial choices that will bring
negative consequences.
The lack of financial education is not only reflected by poor countries but by the wealthy nations as well. As a
matter of fact, a financial literacy report authored by Klapper, Lusardi, and van Oudheusden in 2016 based on the 2014
Standard & Poor’s global survey showed that the United States – touted as the world’s richest country – has only 57%
financially literate adults, only higher by five (5) percentage points with Botswana which has an economy that is roughly
1127% smaller compared to the US (Iacurci, 2019). In the same report, the Philippines only registered an astounding 25%
adult financial literacy rate. In another 2019 report by the Organization for Economic Cooperation and Development
International Network on Financial Education (OECD/INFE) on the policies and initiatives on financial education of the
Asia-Pacific Economic Cooperation (APEC) forum member countries, where the Philippines is one of the forum’s founding
members, it was specified that men, young adults like you and school age children Filipinos are in need of targeted
financial literacy. With these being said, this lesson will serve as one of your guides in exploring and familiarizing
yourselves with some of the fundamental concepts and principles used in saving, budgeting, and investing.
When you borrow money say from a bank, it is expected that you are going to pay an amount that is more than
what you loaned out. When you save up and deposit your money in the bank, the initial amount you have put in the bank
would increase in a specific period. These increases or accumulations of money on top of the original amount, also known
as the principal, is called the interest. From the provided scenarios, interest actually means two things: cost or charge due
from borrowing money as in loan or credit interest, or profit obtained from funds being deposited in a bank, say for
example, through a savings account (Bankrate, n.d.). Interest rate, on the other hand, is simply a percentage of the
principal that is periodically accrued over a certain period (Park, 2012). Banks or any other financial institution use interest
rate to encourage people to deposit money and to make a profit as well (Amadeo, 2020).
A. Simple Interest - the interest earned during each interest period is solely based on the principal amount. It is
calculated using the formula:
𝐼 = 𝑃𝑟𝑡 (Equation 8 – 1)
where
I is the interest earned
P is the principal amount
r is the interest rate (expressed in decimal form)
t is the duration or time (usually expressed in years)
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Note that interest rates are usually expressed as annual interest rates. Unless stated, always assume that
the rate is on a per year basis. Furthermore, there are two classifications of simple interest: ordinary and exact
(Devera, n.d.).
ü Ordinary Simple Interest – one interest period is equal to 360 days only (also called as one banker’s
year). Unless stated, always assume that a simple interest is ordinary.
ü Exact Simple Interest – one interest period is based on the actual number of days in a calendar year (365
for an ordinary year, 366 for a leap year).
In investments, it is expected that the money will grow at a certain period. The accumulated earnings
based on the interest and the principal is called the future value whereas for loans, the total amount of money to
be paid (interest and the principal combined) is called the maturity value (Park, 2012; “Mathematics of Finance,”
n.d.). The formula below is used to calculate for the future or maturity values of money given a simple interest, r:
Jaynelle wants to buy a car worth Php 850000; however, he only has Php 500000 worth of cash in the bank. In
order for him to purchase his much-needed car, he decided to borrow Php 400000 to Gian at 9.5% simple interest
payable for 48 months. How much interest will he pay?
ü It has been indicated in the problem that the interest rate is simple, so we need to use Equation 8-1 to
solve for I.
𝐼 = 𝑃𝑟𝑡
𝐼 = (400000)(0.095)(48)
ü Question: Is it correct to plug-in 48 months as the duration? No, because we always assume that the
simple interest rate is annual unless stated. So, it is necessary to convert 48 months to years.
𝐼 = (400000)(0.095)(4)
A few weeks after Jaynelle acquired his new car, it sustained an engine damage. He needed Php 30000 to have
the engine fixed; however, he has only a few thousand pesos left. Gian, having a big heart for those in need,
learned of this so he offered Jaynelle the amount he needs but with an interest of 5% payable only for 90 days. If
Jaynelle accepts the conditions of the loan, how much interest is due for him?
𝐼 = (30000)(0.05)(0.25)
a. Find the future value of an investment worth Php 25000 at a simple interest of 2.5% after 27 months.
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𝐴 = 𝑃(1 + 𝑟𝑡)
𝐴 = 25000[1 + (0.025)(2.25)]
𝐴 = Php 26406.25
ü Interpretation: A 25000-peso investment will yield a 1406.25-peso increase after 27 months at a simple
interest of 2.5%.
b. Find the maturity value of a loan worth Php 25000 at a simple interest of 2.5% after 27 months.
Solution: The same with the previous example; however, the interpretation would be different because a loan
was made instead of an investment. So, the increase is tantamount to an additional payment on top of the
borrowed amount.
B. Compound Interest – the interest earned is based on both the principal and the previously accrued interest. The
equation provided below is used to determine the compound amount of money at a certain time:
where
A is the compound amount
P is the principal amount
r is the compound interest rate
t is the time
It should be noted that in compound interests, the interest period may be scheduled more than once a
year. In some instances, you may encounter the following terms: annually, semi-annually, quarterly, monthly, or
daily. In each case, the compounding periods or the scheduled interest periods in a year differ as presented in
Table 8-1.
Suppose Php 10000 is deposited for 8 years in an account paying 3.75% per year compounded quarterly. Find
the compound amount in each case.
𝐴 = 𝑃(1 + 𝑖)"
ü Take note that the value of m is 4 because there are four compounding periods in a year if the
compounding schedule is done on a quarterly basis (Refer to Table 8-1).
ü Solving for n,
𝑛 = 𝑚𝑡
𝑛 = (4)(8)
𝑛 = 32
ü Substituting all values to the working equation,
𝐴 = 10000(1 + 0.009375)'+
𝐴 = Php 13479.74
ü Interpretation: After 8 years, you will gain Php 3479.74 from a deposit of Php 10000 compounded
quarterly by 3.75%.
In most financial transactions, the stated or what we call the nominal interest rate is not necessarily the
basis for the computation of accrued interest on the principal during a given period. It is simply a customary way
of stating interest rates that are being compounded more than once in a year (Devera, n.d.; Park, 2012). Such as
in the previous example, Php 10000 was compounded quarterly in a year by 3.75%. We can consider this as the
nominal rate of interest. Another illustration, if we say that an investment or loan has an interest rate of 1%
monthly, we can safely interpret in nominal terms that it is 12% per year compounded monthly.
If nominal interest rate is not the basis for the computation of interest to be given out, then what is? It is
what we call the effective interest rate. It is the exact interest rate being earned on the principal (Devera, n.d.;
Park, 2012). We can compute for the effective interest rate using the following formula:
#
𝑟, = (1 + $)$ − 1 (Equation 8-5)
where
re is the effective interest rate
m is the number of compounding periods per year
r is the stated or nominal interest rate
Take note that the interest rates stated in problems will always be assumed as nominal unless stated otherwise.
Also, in most calculations, it is necessary to convert the nominal rate to effective.
Illustrative Example 5: Nominal and Effective Interest Rates (same problem with Illustrative Example 4)
Suppose Php 10000 is deposited for 8 years in an account paying 3.75% per year compounded quarterly. Find
the compound amount in each case.
0.0375 *
𝑟, = (1 + ) −1
4
𝑟, = 0.03803064737 ≈ 3.803%
ü Notice that the actual interest is higher than what was stated in the problem. Plugging-in this value to the
previous solution, the final answer would be
𝐴 = Php 13536.54
Illustrative Example 6: Nominal and Effective Interest Rates (Sample problem lifted from “Mathematics of
Finance,” (n.d.))
Joe Vetere needs to borrow money. His neighborhood bank charges 8% interest compounded semiannually. An
Internet bank charges 7.9% interest compounded monthly. At which bank will Joe pay lesser amount of interest?
Solution:
ü Compare the effective rates.
%.%- +
Neighborhood bank: 𝑟, = (1 + +
) − 1 = 0.816 or 8.16%
%.%(. /+
Internet bank: 𝑟, = (1 + /+
) − 1 = 0.08192417 ≈ 8.19%
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ü It is advisable for Joe to borrow money in their neighborhood bank because of lower EIR despite a higher
NIR.
Continuous Compounding
Some financial institutions would not simply offer compound interests annually, quarterly, or semi-
annually but unceasingly. This compounding method is called continuous compounding. Banks and other similar
institutions usually do such to attract more potential investors and businesses. If continuous compounding takes
place, the compound amount A can be calculated as follows:
𝐴 = 𝑃𝑒 #! (Equation 8-6)
where
A is the compound amount
P is the principal amount
r is the interest rate
t is the time/duration
Inflation
Inflation is defined as a measure of the rate of increase of the average price level of selected goods
and/or services (Chen, 2020). In a sense, it quantifies the purchasing power of a currency or money. The higher
the inflation, the tendency is that the purchasing power of money becomes less unless the domestic central bank
(Bangko Sentral ng Pilipinas), or any central bank for that matter, implements interest rates that are higher than
the inflation rates.
Folger (2020) explains that inflation and interest rates tend to have an inverse relationship. When inflation
rates are high, the immediate response would be to lower it because the economy at large will suffer so the
central banks would increase interest rates to discourage people from borrowing money and spending further. If
spending decreases and saving up money becomes a trend, the economic activity will slow down resulting to a
decrease in inflation. When inflation rates are low, central banks would lower interest rates for loans to encourage
more borrowings and higher spending to intensify economic growth resulting to high inflation. According to
Milligan (2015), most central banks would prefer an inflation rate between 2 and 2.5%.
To account for the inflation in calculating the present value or present worth of our money, we use the
same formula in calculating for the compound amount (Equation 8-4).
Angel, at a young age of 20, availed a life insurance. The insurance policy she bought guarantees her a Php 5
million return when she reaches age 60. Assuming a 3.25% inflation rate every year, what would be the
purchasing power of the money she is about to receive?
Solution:
ü In this problem, we are asked to find the worth of Angel’s Php 5 million insurance face value in 40 years’
time.
ü Our working equation would be Equation 8-4; however, we must derive another formula from it to solve
the problem.
𝐴 = 𝑃(1 + 𝑖)"
0
𝑃 = (/23)! (Equation 8-7)
ü Equation 8-7 will be used to find for the required in the problem.
Stocks, bonds, and mutual funds are three of the popular investment instruments nowadays. An individual or a
business entity and even governments may avail whatever is suitable and appropriate for them to invest in. Since these
are investment vehicles, they carry risks and different levels of return rates.
Stocks are often heard or read in business news sites. When you say stocks, these are pieces or shares of a
publicly listed corporation. Being a publicly listed company, you permit the people to buy a part of your business which will
essentially render them to be a part-owner of your corporation. In the Philippines, companies seek to be publicly listed
through the Philippine Stock Exchange (PSE). PSE is where all the trading of shares happens. The very reason why
some companies list themselves through stock exchanges is because they need to boost their financial resources.
Those entities who buy or own stocks are called stockholders or shareholders. Being a stockholder, you are
entitled to some perks and rewards. Some corporations, such as those in the US, give out discounts or freebies to their
stockholders apart from the dividends that they get. Dividends are profits of a corporation that are paid to the
stockholders. Payment of these may take in the form of cash or additional stocks and the amount of divided to be
distributed is determined by a company’s board of directors (Chen, 2020). Take note that dividends vary in each
corporation because it depends on the market condition and the financial performance of the company. If it rakes high
profits, then you can expect to have high dividends as well. If the company does well and the market is stable, you may
see your stock prices increase.
Apart from the dividends, you earn money from stocks when you sell your own shares. Of course, you will only
want to sell your shares if the current price is more than the value when you bought it. There are online trading platforms
which facilitate stock trading. From these platforms, you get to see the financial history and performance of the companies
you are willing to be a part of. Engaging in stocks is not a simple purchasing and selling game. Like most buy and sell
businesses, you still need to do some research to know the risks and returns or else you will end up losing much of the
money you are about to invest.
Bonds, on the other hand, are investment instruments issued by governments or corporations. If stocks would
translate to ownership, bonds would be viewed as a loan. For example, if the Philippine government issues bonds worth
Php 10 million and you are about to buy these bonds (if you buy bonds, you are called a bondholder), you are essentially
lending the government Php 10 million and in return, they will pay you a fixed amount of interest until the maturity date
(maturity date means the period when the lender receives the face value of the bond). Maturity of a bond usually takes
months to years. Between stocks and bonds, the latter is considered a safer asset because it is a fixed income asset and
the financial laws guarantee the bond investors to be paid by the bond issuer (Fonville, 2020).
In mutual funds, people invest to create a large pool of fund for them to purchase a diversified portfolio of assets.
A fund manager oversees monitoring and performing trades on behalf of the investors. The fund manager may opt to
invest the money to whatever investment vehicle he/she may deem fit. Once you opt to buy or avail a mutual fund, the
share or piece you are buying is called the net asset value. If you want to learn more of these and other investment
instruments, there are several websites you can access such as Investopedia, PSE Academy, and the like.
References
Amadeo, K. (July 1, 2020). Interest rates and how they work. Retrieved July 15, 2020 from
https://www.thebalance.com/what-are-interest-rates-and-how-do-they-work-
3305855#:~:text=They%20pay%20interest%20rat
es%20to,for%20both%20depositors%20and%20borrowers.
AmosWEB. (n.d.). Standard of deferred payment. Retrieved July 15, 2020 from
https://www.amosweb.com/cgibin/awb_nav.pl?s=wpd&c=dsp&k=standard%20of%20deferred%20payment
Bankrate. (n.d.). Interest. Retrieved July 16, 2020 from https://www.bankrate.com/glossary/i/interest/
Chen, J. (March 26, 2020). Inflation. Retrieved July 19, 2020 from
https://www.investopedia.com/terms/i/inflation.asp#:~:text=Inflation%20is%20a%20quantitative%20measure,it%2
0did%20in%20prior%20periods.
Chen, J. (July 18, 2020). Guide to dividend investing. Retrieved July 19, 2020 from
https://www.investopedia.com/terms/d/dividend.asp
Devera, E. E. (n.d.). Engineering Economics. ____________________.
Folger, J. (April 28, 2020). Hat is the relationship between inflation and interest rates?. Retrieved July 20, 2020 from
https://www.investopedia.com/ask/answers/12/inflation-interest-rate-relationship.asp
Fonville, M. (March 16, 2020). Bonds vs stocks vs mutual funds: What you need to know. Retrieved July 18, 2020 from
https://www.covenant
wealthadvisors.com/post/bonds-vs-stocks-vs-mutual-funds
Houghton Mifflin Harcourt. (n.d.). Economics: Functions of money. Retrieved July 15, 2020 from
https://www.cliffsnotes.com/study-guides/economics/money-and-banking/functions-of-money
Iacurci, G. (March 2, 2019). Financial literacy: An epic fail in America. Retrieved July 16, 2020 from
https://www.investmentnews.com/financial-literacy-an-epic-fail-in-
america78385#:~:text=Americans%20fall%20short&tex
t=To%20put%20that%20into%20perspective,whose%20economy%20is%201%2C127%25%
Klapper, L., Lusardi, A. & van Oudheusden, P. (2016). Financial literacy around the world: Insights from the Standard &
Poor’s Ratings Services global financial literacy survey. Retrieved July 16, 2020 from https://gflec.org/wp-
content/uploads/2015/11/3313-Finlit_Report_FINAL-5.11.16.pdf?x49160
Lumen Learning. (n.d.). Boundless economics: The monetary system. Retrieved July 15, 2020 from
https://courses.lumenlearning.com/boundless-economics/chapter/introducing-money/
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Mathematics of finance. (n.d.). Simple and compound interest. Retrieved July 21, 2020 from
https://www.pearson.com/content/dam/one-dot-com/one-dot-com/us/en/higher-ed/en/products-services/course-
products/lial-applied-mathematics-info/pdf/LGR-Finite-Ch5.pdf
Milligan, B. (January 13, 2015). How can inflation be good for you?. BBC News. Retrieved July 19, 2020 from
https://www.bbc.com/news/business-
30778491#:~:text=When%20inflation%20is%20too%20high,real%20return%20on%20their%20money.
OECD. (2019). OECD/INFE Report on financial education in APEC economies: Policy and practice in a digital world.
Ponnusamy, S. (October 17, 2016). Functions of money in the modern economic system. Retrieved July 15, 2020 from
https://owlcation.com/social-sciences/Functions-of-Money-in-Modern-Economic-System
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https://www.gisreportsonline.com/money-makes-the-world-go-round,economy,1687.html
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Assessing Learning (Unit 8)
Directions: For multiple choice questions, simply encircle the letter of the correct answer and provide a solution if
necessary to support your answer. For essay type questions, limit your answers to five (5) sentences only. For problem
solving, show your solutions solve as neatly as possible, and box your final answers. If it requires you to use another
sheet of paper for the problem-solving part, please do so. Non-compliance to these shall guarantee a deduction in your
scores.
2. Person A invests Php 4500/month for the first 10 years of his professional in an investment vehicle that gives 12%
per annum interest and saves nothing for the next 30 years. Person B chose to spend much of his money partying
and purchasing the latest gadgets and other items for the first 10 years of his working life, then he suddenly
realized he needed to invest the same amount as well for the next 30 years of his life at the same investment
vehicle. Who between the two would end up having more money?
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3. The amount of Php 20000 was deposited on a bank earning an interest of 6.5% per annum. Determine the total
amount at the end of 7 years if the principal and interest were nit withdrawn during this period.
4. Which of the following is the interest rate not given as an effective rate?
a. Effective 12% per year compounded monthly
b. 10% per year compounded daily
c. 2% per month compounded monthly
d. 5% per year
6. Danny borrowed Php 70000 from her friend to buy a brand-new laptop. He repaid his friend after 9 months, at an
annual interest rate of 5.2%. Find the total amount he repaid and determine how much of this amount is the
interest.
An accountant of a certain company was not able to pay the company’s income tax amounting to Php 34 786 124.98 on
time. The internal revenue bureau fined the company by charging a penalty based on an annual interest rate of 12.5% for
the 30 days the payment was late. (a) Find the total amount paid by the company. (b) What was its purchasing power at
the time when an inflation of 2.5% was prevailing?