The Mathematics of Finance

Finance is indispensable component of our daily needs. Many things can be made possible
because of finance. The financial capability of an individual, a company or an agency
sometimes determine the success of some endeavor that involves finances. A business firms, for
example, rely most on the financial aspects of the business, to maintain its resources such as
people, materials, equipment and labor. In some ways, these firms may resort to borrowing
money from a lending institutions in order to augment the firm’s financial needs at a certain rate
of interest.

On the other hand, banks, government agencies, and even private institutions and lenders earn
money in the form of interest from the money they lend to borrowers.

For some personal conditions, we can even borrow money using some high technology systems
such as the use of credit cards.

This unit covers nine different topics in dealing with finances: the computation of simple and
compound interest, credit cards, consumer loans, bonds and mutual funds, loan amortization and
home ownership. Each aspect is provided with clear and concrete examples for your easy
understanding.

Upon the completion of this unit, you are expected to:

a. Define simple interest compound interest and differentiate them from each other;
b. Solve problems involving simple and compound interest;
c. Relate the knowledge of the different topics discussed into practical life situations; and
d. Appreciate Mathematics as a practical arts and science for everyday life.

Topic 1: Simple Interest

One of the best ways to secure one’s money is to deposit it to the bank. For some period of time,
the depositor gets something in return for the amount deposited. The person who deposited the
money is called the depositor, while the amount the depositor gets in return is called interest.
The sum of money invested in the bank is called the principal.

Sometimes, when people need to secure fund for a limited time for some reasons, they resort to
borrowing from any private or government lending agencies or institutions, or even to a private
individual at a certain rate of interest. The person, agency or institution who lends money is
called the lender while the person who borrows money is called the debtor or maker.

The sum of money paid in return for the use of the money is also called the interest.

The capital or sum of money lend or invested is called the principal, while the fractional part of
principal that is paid on the loan is called the rate of interest, and it is usually expressed in
percent. The specific time or duration (years, months, days) for which the money is borrowed is
called the term of the loan. The interest is calculated based on the interest rate and the term of
the loan.

On the other hand, the sum of the principal and the interest is called the maturity value also
called the final amount, while the date to which the term of the loan ends is called the maturity
date.

Loaned money covers some charges such as processing fee, insurance, and other legitimate fees.
These charges are deducted from the principal loan. The amount received by the debtor or maker
after deducting the legitimate fees is called the present value or proceed of the loan.

This part of the unit dwells mainly on simple interest and expose you to some real-life examples
for your better appreciation of simple interest.

Upon the completion of this topic, you are expected to:

a. recognize terms related to simple interest;

b. calculate simple interest on ordinary and exact time, using actual and

approximate time;

c. solve practical problems involving simple interest; and

d. appreciate the importance of simple interest into real-life situations
Simple interest (I) is defined as the product of the principal (P), rate (r) and time (t).

In formula:

From the original formula, other formulas can be derived such as:

I
① When Principal is unknown: P=
rt
I
② When the rate is unknown: r =
Pt
I
③ When the time is unknown: t=
Pr

In computing the simple interest, we always arrive at a final amount (F). The final amount is the
sum of the principal and the interest. In formula:

Before you proceed, be sure to learn more about the following concepts of simple interest:

Term of the loan

The term of the loan is the period during which the borrower had used the money. The term or
time may be expressed in days, months or years. In computing the simple interest, the time (t)
should always be expressed in years. If the time is expressed in days or months, convert it into
years,
Note that in business, the interest rate is expressed in percent (%). In computing the interest, it is
necessary to convert the rate into fraction or decimal equivalent.

Computation of Simple Interest

Having understood the different concepts on simple interest, you are now ready to compute the
simple interest.

Example 1:

1. Find the interest and amount on P55,500 at 5% simple interest for 4 years.
Solution:

Given: P = P55,500 Find: a. Interest (I)

r= 5% (0.05) b. Amount (F)

T= 4 years

a. Find the interest

I =Pxrxt

= P55,500 x .05 x 4

= P11,100 - the interest for 4 years

b. Final Amount

F =P+I

= P55,500 + 11,100

= P66,600

The invested amount will become P66,600 after 4 years.

Example 2. Find the final amount and interest on P150,000 invested at

6 1/2% simple interest for 4 years and 10 months.

Solution:

Given: P = P150,000 Find: a. Interest (I)

r = 6 1/2% (.065%) b. Final Amount (F)

t = 4 years and 10 months.

1. First, convert the time into years:

 Since time = 4 years and 10 months, then

t = 4 years + (10 months÷12)

= 4+ 0.833

=4.833 years

2. Solve for the interest:

I=Pxrxt

= P150,000 x .065 x 4.833

= P47,121.75

3. Solve the Final Amount:

F=P+I

= P150,000 + P47,121.75

= 197,121.75

The investor will get back a total of P197,121.75 for investing his/her money for a period of 4
years and 10 months.

A. Fill in the boxes with the correct figure if possible. You may use calculators or any
computing gadgets available.
I P r t F
P15,500 2 years,6 P22,300
months
P5,350 3.5% 4 years
P25,300 4 1/2% 4 years, 3
months
P4,350 P23,450 5 years, 2
months
P55,000 5.75% 3 years

B. Problem Set: Solve the following problems. Show your complete solutions. Use a blank
sheet enclosed for your answers.
1. Find the Final Amount and interest on P20,000 for 65 days at 5.25% simple interest.

2. A businessman charges his client P2,750 on a loan of P15,800 for 2 years and 3 months. What
rate is effected on the loan?

3. Nina borrowed P50,000 on April 21, 2018 and repays the loan on April 21, 2019 with an
interest rate of 5-1/2%. Find the amount she paid.

4. Three months after borrowing money, John Mark pays an interest of P2,700. How much did
he borrow if the interest rate is 5.25%?

5. Pamela loans P20,000 at 4.75% simple interest. How long will it take her to get P2,500
interest?

Topic 2: Computing the Simple Interest using Ordinary and Exact

Time (Ordinary and Exact Interest) -

As seen earlier, there are some instances when the term of the loan is in given number of days. It
is always, of course, the interest of every lending agencies to have their money loaned earn
higher interest.

On the other hand, amount invested in these agencies tend to, as much as possible give out
smaller interest to the investors. This system is what is called the “Banker’s Rule”. The rule says
that for a certain lender, be it agency or private individuals, the tendency is for them to engage
into a situation where they get bigger interest. For this reason, two methods of computing the
simple interest are involved. In this topic, you will learn how the above situation is applied into
some practical circumstances.

Upon the completion of this topic, you are expected to:

a. compute for the ordinary and exact interest;

b. identify the advantages/disadvantages of each type of interest.
c. appreciate the importance of each type of computing the interest in real life situation.
Answers to above questions are very important as you go along this topic, and as you experience
computing for the simple interest using the ordinary and exact time.

Ordinary interest is computed using the ordinary time, while exact interest is computed using the
exact time.

Ordinary Interest

To find the ordinary interest, use the formula for simple interest. In this case, the time
expressed in days is divided by 360. This is because each month of the year is assumed to have
30 days.

We use the symbol Io to denote ordinary interest. Then we have the formula for ordinary
interest as:

Note: If the time is expressed in years or months, be sure to change it into days to be able to
divide it by 360.For instance, the time is 2 years and 3 months , change the time first into
days following the steps in the previous lessons.

Example:

Find the ordinary interest on P15,500 for 130 days, at 5 3/4% simple interest.

Solution:

Given: P= P15,500

r= 5 3/4% (.0575)

t= 130 days.
Find: Ordinary Interest

I o=Pr (360t )
= P15,500 x 0.0575 x (130 ÷ 360)

= P321.840

The ordinary interest of the money invested/borrowed for 130 days is P321.84.

Exact Interest

To find the exact interest, use the formula for simple interest, dividing the time expressed in
days by 365.

The number of days is calculated using the exact number of days each month of the year has,
such that January has 31, February has 28 (except for leap year), March has 31, and so on.

We use the symbol Ie to denote exact interest.

To calculate the exact interest, the following formula is used:

Let us use the example above to illustrate the computation of exact interest (Ie).

Example.

Find the exact interest on P15,500 for 130 days, at 5 3/4% simple interest.

Solution:

Given: P= P15,500

r= 5 3/4% (.0575)
 t= 130 days.
Find: Exact Interest (Ie)
I e =Pr ( 365t )
= P15,500 x 0.0575 x (130 ÷ 365)

= P317.43

Using exact time, the interest on P15,500 invested/borrowed for 130 days is P317.43.

Let’s compare the ordinary and exact interest.

Ordinary Exact
Principal P15,500 P15,500
rate 5 3/4% 5 3/4%
Time (130 days) 0.361 year 0.356 year
interest earned P321.84 P317.43

Remember!

a. Ordinary interest is always larger than the exact interest.

b. In computing the simple interest, when there is no type of interest is specified, always
compute it using ordinary interest.

Congratulations! You’ve just learned on how to compute the simple interest using ordinary and
exact time.

Topic 3: Computing the Simple Interest using Actual and Approximate

Time (Interest between Dates)

In previous lessons, the time for which the interest is computed is given in years, months and
days. For some instances when interest is to be computed from a certain inclusive date, it is
necessary that we determine the number of inclusive days. We can do this in two methods: Using
the actual and approximate time. In same way, we can compute simple interest in two methods-
using the actual and approximate time.

In this topic, you will understand that the term (time) of the loan plays a very vital role in the
computation of the interest.
Upon the completion of this topic, you are expected to:

a. determine the actual and approximate number of days between inclusive dates;
b. solve more challenging problems on interest involving the four methods: (Ordinary Interest
on actual time, Ordinary interest on approximate time, Exact interest on actual time, and
Exact interest on approximate time); and
c. compare the four methods of computing interest.
Finding the actual and approximate time

When the time or term of the loan is expressed between dates, it is necessary to determine the
actual and approximate time.

Actual time is the exact number of days in any given month. Approximate time is when all the
months within the year are assumed to contain 30 days each.

Let us work on the following examples to show how to determine the actual and approximate
time.

Example.

Find the actual and approximate time from April 21, 2018 to October 4, 2018.

Solution:
Month Approximate Time Actual Time

April 9 (30-21) 9 (30-21)

May 30 31
June 30 30
July 30 31
August 30 31
September 30 30
October 4 4
TOTAL 163 days 166 days

Note: When a type of interest is not specified in any problem, the ordinary interest, on actual
time will be used. This rule is also called the Banker’s Rule.

Now, let’s compute the simple interest on actual and approximate time.

Example 1.

Find the interest on P50,000 at 4.5% from January 17, 2019 to July 7, 2019, both using actual
and approximate time.

Solutions:
A. First find the number of days between January 17, 2019 to July 7, 2019 using actual and
approximate time.
Month Approximate Time Actual Time

January 17 14 14 (31-17)
February 30 28
March 30 31
April 30 30
May 30 31
June 30 30
July 7 7 7
TOTAL 171 days 171 days

Note that the actual and approximate time are the same. This is because of February which, on
actual time has only 28 days (except leap year), while on approximate time, it is assumed to have
30 days.

B. Compute the simple interest using the actual time.

Since there is no type of interest specified in the problem, then use ordinary interest (Io) in
computing for the simple interest. Let us then divide the time by 360.

Using the formula for simple interest, I=Prt where t is divided by 360.

Given: P = P50,000

r = 4.5% (.045)

t = 171 days (171÷360)

= 0.475

Find: Interest

Solution:

I = Prt

= 50,000 x .045 x 0.475

= P1,068.75
Using actual time, the interest on P50,000 at 4.5% from January 17 to July 7, 2019 is
P1,068.75.

C. Compute the Interest using approximate time.

Since approximate time (171 days) is the same with the actual time, you will then get the same
result for the interest using approximate time which is P1.068.75.

Example 2:

Find the interest on P25,000 using ordinary and exact interest, on actual and approximate time at
4% from July 2, 2018 to November 27, 2018.

In the above example, interest will be computed using the four methods:

a. Ordinary interest for actual time (Io-actual)

b. Ordinary interest for approximate time (Io-approx)
c. Exact interest for actual time, and (Ie-actual)
d. Exact interest for approximate time (Ie-approx)

Solution:

Given: P = P25,000

r = 4%

t = July 2, 2018 to November 27, 2018

Find: Io-Actual, Io-approx, Ie actual, Ie approx

A. Find first the actual and approximate time
Approximate time Actual time

Year Month Day November 27 = 331

2018 11 27 July 2 = 183

2018 7 2 -----------------------------------

------------------------------------------- Difference = 148 days

Diffrence = 4 25

4 x 30 = 120 + 25

= 145 days

Since the actual and approximate time are determined, you are now ready to compute the
interests.

B. Find the Ordinary interest using actual time (148 days). Remember that the divisor of the
time for ordinary interest is 360.

Io actual = Prt

= 25,000 x .04 x (148÷360)

= P411.11

The ordinary interest on P25,000 using actual time is P411.11

C. Find the Ordinary Interest using approximate time (145 days). Again the time will be
divided by 360 for Ordinary time.

Io approx = Prt

= 25,000 x .04 x (145÷360)

 = 402.78

The ordinary interest on P25,000 using approximate time is P402.78

D. Find the Exact Interest using actual time (148 days). Remember that the time shall be
divided by 365 for exact interest.

Ie-actual = Prt

= P25,000 x .04 x (148÷365)

= P405.48

The exact interest on P25,000 using actual time is P405.48.

E. Find the Exact Interest using Approximate Time (145 days).

Ie- approx = Prt

= 25,000 x -04 x (145 ÷365)

= P397.26

The exact interest on P25,000 using actual time is P397.26

Now, let us summarize the computed interests using the four methods:
Actual time Approximate time
Ordinary interest P411.11 P402.78
Exact Interest P405.48 P397.26

Based on above summary, you note that ordinary interest is always lower than the exact interest.

On the other hand, interest computed using the actual time is always higher than the interest
computed on approximate time. This is because actual time uses the actual number of days in a
month, compared to approximate time, which allocates 30 days for each month of the year.

Congratulations. You have just learned how simple interest can be computed using the four
methods.