Chapter 2: Mathematics of Finance

1 Simple Interest (F)

2 Compound Interest (F)

3 Present Values and Future Values of Annuities (C)

4 Loans and Amortization

Le Ba Khiet, Phd. Faculty of Mathematics & Statistics, TDTU November 4, 2022 1 / 10

2.3.1 Future Values of Annuities

Example 1
Van invests $2, 000 at the end of each year for 10 years (to age 28) in
an account that pays 12% compounded annually. How much money
does Van have at age 28?

→ Van’s contributions form an annuity.

What is an annuity?
An annuity is a financial plan characterized by regular payments. For
example

+ a savings plan: the regular payments are contributions to the account

+ a payment plan (such as for retirement): regular payments are made

from an account, often to an individual.

Le Ba Khiet, Phd. Faculty of Mathematics & Statistics, TDTU November 4, 2022 2 / 10

2.3.1 Future Values of Annuities

Example 1
Van invests $2, 000 at the end of each year for 10 years (to age 28) in
an account that pays 12% compounded annually. How much money
does Van have at age 28?

→ Van’s contributions form an annuity.

What is an annuity?
An annuity is a financial plan characterized by regular payments. For
example

+ a savings plan: the regular payments are contributions to the account

+ a payment plan (such as for retirement): regular payments are made

from an account, often to an individual.

Le Ba Khiet, Phd. Faculty of Mathematics & Statistics, TDTU November 4, 2022 2 / 10

2.3.1 Future Values of Annuities

Future Values of Annuities

The sum of all payments plus all interest earned.

Ordinary Annuities
Characterized by the same payments made at the end of each equal
interval.

Example 2
Suppose you invested $100 at the end of each year for 5 years in an
account that paid interest at 10% compounded annually. How much
money would you have in the account at the end of the 5 years?

Le Ba Khiet, Phd. Faculty of Mathematics & Statistics, TDTU November 4, 2022 3 / 10

2.3.1 Future Values of Annuities

Future Values of Annuities

The sum of all payments plus all interest earned.

Ordinary Annuities
Characterized by the same payments made at the end of each equal
interval.

Example 2
Suppose you invested $100 at the end of each year for 5 years in an
account that paid interest at 10% compounded annually. How much
money would you have in the account at the end of the 5 years?

Le Ba Khiet, Phd. Faculty of Mathematics & Statistics, TDTU November 4, 2022 3 / 10

2.3.1 Future Values of Annuities

Future Values of Annuities

The sum of all payments plus all interest earned.

Ordinary Annuities
Characterized by the same payments made at the end of each equal
interval.

Example 2
Suppose you invested $100 at the end of each year for 5 years in an
account that paid interest at 10% compounded annually. How much
money would you have in the account at the end of the 5 years?

Le Ba Khiet, Phd. Faculty of Mathematics & Statistics, TDTU November 4, 2022 3 / 10

2.3.1 Future Values of Annuities

The future value of the annuity is

S = 100 + 100 × 1.1 + 100 × 1.12 + 100 × 1.13 + 100 × 1.14

= 100(1 + 1.1 + 1.12 + 1.13 + 1.14 )
= R(1 + a + a2 + a3 + a4 )
a5 − 1 (1 + i)5 − 1 (1 + i)5 − 1 (1 + i)n − 1
= R =R =R =R ,
a−1 (1 + i) − 1 i i
where R = 100, a = 1 + i = 1 + 0.1 and n = 5.
Le Ba Khiet, Phd. Faculty of Mathematics & Statistics, TDTU November 4, 2022 4 / 10
2.3.1 Future Values of Annuities

Lemma
We have
an − 1
1 + a + a2 + ... + an−1 = , where a > 1.
a−1

Proof.
Note that

(a − 1)(an−1 + an−2 + ... + a + 1)

= (an + an−1 + ... + a2 + a) − (an−1 + an−2 + ... + a + 1)
= an − 1

and the conclusion follows.

Le Ba Khiet, Phd. Faculty of Mathematics & Statistics, TDTU November 4, 2022 5 / 10

2.3.1 Future Values of Annuities

Lemma
We have
an − 1
1 + a + a2 + ... + an−1 = , where a > 1.
a−1

Proof.
Note that

(a − 1)(an−1 + an−2 + ... + a + 1)

= (an + an−1 + ... + a2 + a) − (an−1 + an−2 + ... + a + 1)
= an − 1

and the conclusion follows.

Le Ba Khiet, Phd. Faculty of Mathematics & Statistics, TDTU November 4, 2022 5 / 10

2.3.1 Future Values of Annuities

How to find the future value?

If a periodic payment R is made for n periods at an interest rate i per
period, the future value of an ordinary annuity is given by

(1 + i)n − 1
S=R .
i

Example 3
Hung invests $1, 000 at the end of each year for 30 years (to age 60) in
an account that pays 12% compounded annually. How much money
does Hung have at age 60?

Le Ba Khiet, Phd. Faculty of Mathematics & Statistics, TDTU November 4, 2022 6 / 10

2.3.1 Future Values of Annuities

How to find the future value?

If a periodic payment R is made for n periods at an interest rate i per
period, the future value of an ordinary annuity is given by

(1 + i)n − 1
S=R .
i

Example 3
Hung invests $1, 000 at the end of each year for 30 years (to age 60) in
an account that pays 12% compounded annually. How much money
does Hung have at age 60?

Le Ba Khiet, Phd. Faculty of Mathematics & Statistics, TDTU November 4, 2022 6 / 10

2.3.1 Future Values of Annuities

Example 4
Thien An invests $1, 000 at the end of each of 8 years in an account
that earns 12% compounded annually.
After the initial 8 years, no additional contributions are made, but the
investment continues to earn 12% compounded annually for 30 more
years (until An is age 60).
How much does An have at age 60?

Le Ba Khiet, Phd. Faculty of Mathematics & Statistics, TDTU November 4, 2022 7 / 10

2.3.1 Future Values of Annuities

Remark
Thien An contributes $8, 000 ($1, 000/year for 8 years) to obtain $
368,497.75 at age 60 while Phi Hung invests $30, 000 ($1, 000/year for
30 years) but only receive $241, 332.68 at age 60.
→ the power of time and compounding.

Example 5 (Time to Reach a Goal)

A small business invests $3000 at the end of each month in an account
that earns 10% compounded monthly. How long will it take until the
business has $180, 000 to buy its own office building?

Le Ba Khiet, Phd. Faculty of Mathematics & Statistics, TDTU November 4, 2022 8 / 10

2.3.1 Future Values of Annuities

Remark
Thien An contributes $8, 000 ($1, 000/year for 8 years) to obtain $
368,497.75 at age 60 while Phi Hung invests $30, 000 ($1, 000/year for
30 years) but only receive $241, 332.68 at age 60.
→ the power of time and compounding.

Example 5 (Time to Reach a Goal)

A small business invests $3000 at the end of each month in an account
that earns 10% compounded monthly. How long will it take until the
business has $180, 000 to buy its own office building?

Le Ba Khiet, Phd. Faculty of Mathematics & Statistics, TDTU November 4, 2022 8 / 10

2.3.1 Future Values of Annuities
Annuities Due
Unlike an ordinary annuity, an annuity due has the periodic payments
made at the beginning of the period.

Thus the future value of an annuity due is

(1 + i)n − 1
Sdue = S(1 + i) = R (1 + i).
i
Le Ba Khiet, Phd. Faculty of Mathematics & Statistics, TDTU November 4, 2022 9 / 10
2.3.1 Future Values of Annuities

Example 6
Find the future value of an investment if $200 is deposited at the
beginning of each month for 7 years and the interest rate is 9.6%
compounded monthly.

Exercises
Page 30: 2.3: 1–3

Le Ba Khiet, Phd. Faculty of Mathematics & Statistics, TDTU November 4, 2022 10 / 10

2.3.1 Future Values of Annuities

Example 6
Find the future value of an investment if $200 is deposited at the
beginning of each month for 7 years and the interest rate is 9.6%
compounded monthly.

Exercises
Page 30: 2.3: 1–3

Le Ba Khiet, Phd. Faculty of Mathematics & Statistics, TDTU November 4, 2022 10 / 10