LESSON

7 MATHEMATICS OF FINANCE

LESSON 7.1: Simple Interest

In any financial transaction, there are two parties involved: an investor, who is lending money to
someone, and a debtor, who is borrowing money from the investor. The debtor must pay back the money
originally borrowed, and also the fee charged for the use of the money, called interest. From the investor’s
point of view, interest is income from invested capital. The capital originally invested in an interest
transaction is called the principal. The sum of the principal and
interest due is called the amount or accumulated value. Any interest transaction can be described by the
rate of interest, which is the ratio of the interest earned in one-time unit on the principal.
In early times, the principal lent and the interest paid might be tangible goods (e.g., grain). Now,
they are most commonly in the form of money. The practice of charging interest is as old as the earliest
written records of humanity. Four thousand years ago, the laws of Babylon referred to interest payments on
debts.
At simple interest, the interest is computed on the original principal during the whole time, or term
of the loan, at the stated annual rate of interest.
We shall use the following notation:
P = the principal, or the present value of S, or the discounted value of S, or the
proceeds.
I = simple interest.
S = the amount, or the accumulated value of P, or the future value of P, or the
maturity value of P.
r = annual rate of simple interest.
t = time in years.
Simple interest is calculated by means of the formula
I =Prt Formula 1
The time t must be in years. When the time is given in months, then
number of months
t= .
12
Example:
Suppose Rancho wanted to invest an amount of ₱50 000.00 for 2 years at a financial institution that
gives a simple interest of 3% per year. The interest rate was given to Rancho by the financial
institution on the assumption that he cannot withdraw the investment within the 2-year period. How
much is Rancho’s earning on the investment after the 2-year period?

Solution:

Given: P = 50 000,r = 0.03, t = 2 Solve for: I

I =Prt
¿(50 000)(0.03)(2)
I =3 000

From this we conclude that, Rancho’s earning on the investment after the 2-year period is ₱ 3
000.00.
When the time is given in days, there are two different varieties of simple interest in use:

number of days
1. Exact interest, where t=
365
i.e., the year is taken as 365 days (leap year or not).

number of days
2. Ordinary interest, where t=
360
i.e., the year is taken as 360 days.

Example:
Find the ordinary and exact interest at 5% on ₱ 5 000.00 at the end of 59 days.
Solution:

Ordinary Interest: I =Prt ¿ (5 000)(0.05) ( 360

59
) ¿ ₱ 40.97
Exact Interest: I =Prt ¿ (5 000)(0.05) ( 365
59
) ¿ ₱ 40.41
Notice that ordinary interest is always greater than the exact interest and thus it brings increased
revenue to the lender.

LESSON 7.2: Calculations on the Time Between Dates

In computing interest, we include the last day but not the first day in counting the time between two
dates. Sometimes the time between two dates is counted under the assumption that each month has 30
days; we shall call the result the approximate time. Usually, it is less than the actual time.

actual time
Ordinary Simple Interest for the Actual Number of Days: (Banker’s Rule)
360
actual time
Exact Simple Interest for the Actual Number of Days:
365
approximate time
Ordinary Simple Interest for the Approximate Number of Days:
360
approximate time
Exact Simple Interest for the Approximate Number of Days:
365
Note: The Banker’s Rule or Ordinary Simple Interest is applied whenever a given problem does not specify
the time factor to be used.

Examples:
1. Find the actual and approximate time from May 1, 2024 to September 15, 2024.
Solution:

Actual Time Approximate Time

May 30 May 29
June 30 June 30
 July 31 July 30
August 31 August 30
September 15 September 15
137 134

2. At 8%, find the interest on ₱ 10 000.00 from May 1, 2024 to September 15, 2024.
Solution:
Using the result in the previous example, the interest could be computed in the following ways.

Ordinary (Actual) I =Prt ¿ (10 000)(0.08)( 137

360 )
¿ ₱ 304.44

I =Prt ¿ (10 000)(0.08)(

365 )
137
Exact (Actual) ¿ ₱ 300.27

I =Prt ¿ (10 000)(0.08)(

360 )
134
Ordinary (Approximate) ¿ ₱ 297.78

I =Prt ¿ (10 000)(0.08)(

365 )
134
Exact (Approximate) ¿ ₱ 293.70

LESSON 7.3: Accumulation and Discount at

Simple Interest

Accumulating at Simple Interest Rate

From the definition of the amount S, we have

S=P+ I

By substituting for I = Prt, we obtain S in terms of P, r, and t:

S=P+ Prt
S=P (1+rt) Formula 2

The factor (1+rt ) in Formula 2 is called an accumulation factor at a simple interest rate r and the
process of calculating S from P by Formula 2 is called accumulation at a simple interest rate r .
We can display the relationship between S and P on a time diagram.

Alternatively,

Example:
May wants to borrow ₱40 000.00 from a bank that gives an annual interest rate of 4.5%. However,
she only wants to borrow the fund for a 9-month period and will be able to pay the bank immediately
after 9 months. What is the accumulated value of the amount borrowed after the 9-month period?
Solution:
 9
Given: P = 40 000,r = 0.045, t = = 0.75 Solve for: S
12
S=P (1+rt)
¿ ( 40 000 ) [1+ ( 0.045 ) ( 0.75 ) ]
¿ ( 40 000 ) (1+0.03375)
¿ ( 40 000 ) (1.03375)
S=41 350

Thus, after nine months, May will pay the bank ₱ 41, 350.00.

If a sufficient number of the variables P, I , S, r andt are given, the others can be found by use of
Formula 1 and 2.
Examples:

1. What is the simple interest rate applied if an investment of ₱37 500.00 accumulates to ₱ 41 812.50
in the period of 5 years?
Solution:
I
From the formula I =Prt , we have r =
Pt
.
Given: I = 41 812. 50 – 37 500 = 4 312.50, P = 37 500, t = 5 Solve for: r
I
r=
Pt
4 312.50
r=
(37 500)(5)
4 312.50
=
187 500
r = 0.023 or 2.3%

Thus, the simple interest rate applied is 2.3%.

2. The repayment on a loan was ₱16 275.00. If the loan was for 15 months at 6.8% interest a year,
how much was the principal?
Solution:
S
From the formula 𝑺¿ P(1+rt ), we have 𝑃 =
1+ rt
.
15
Given: S = 16 275,r = 0.068, t = = 1.25 Solve for: P
12
S
𝑃=
1+ rt
16 275
=
1+(0.068)(1.25)
16 275
=
1+ 0.085
16 275
=
1.085
𝑃 = 15 000
The principal amount was ₱ 15 000.00.
Discounting at Simple Interest Rate
 To discount ₱ S for t years means to find the present value ₱ P of ₱ S of on a day which is t years
before ₱ S is due. The difference between the future value ₱ S and its present value ₱ P is called
the discount on ₱ S. That is, the discount on S is ( S−P ) .Since S=P+ I , then I =S−P . Hence, the
symbol I has been given two useful names:

I =¿ the interest on the present value P;

the discount on the amount S.

In Example number 2, we discounted ₱16 275.00 for 15 months at 6.8% simple interest, and found
the principal amount or the present value 𝑃 = ₱ 15 000.00. The discount on ₱ 16 275.00
was

I =discount =16 275−15 000=₱ 1275.00 .

When money is worth the rate r , simple interest:

I. To accumulate a principal P for t years, use I =Prt and S=P+ I .
II. To discount an amount P for t years, substitute the given values of S, r , andt in
S=P (1+rt) and solve for P.

LESSON 7.4: Compound Amount and Compound Interest

Terminologies for Compound Interest

If, at stated intervals during the term of an investment, the interest due is added to the principal and
thereafter earns interest, the sum by which the original principal has increased by the end of the term of the
investment is called compound interest.
At any date, the total amount due, which consists of the original principal plus the compound
interest, is called compound amount. The time between successive conversions of interest into principal
is called conversion period.
Example:
Find the compound amount and the compound interest at the end of one year if ₱1 000.00 is invested at
8% compounded quarterly.
Solution:

1. The conversion period is 3 months. Interest is earned at the rate 8% per year during each period, or
at the rate 2% per period, on all principal on hand at the beginning period.
At the end of 3 months, ₱20.00 interest is due; new principal is ₱1 020.00.
At the end of 6 months, ₱20.40 interest is due; new principal is ₱1 040.40.
At the end of 9 months, ₱20.81 interest is due; new principal is ₱1 061.21.
At the end of 1 year, ₱21.22 interest is due; new principal is ₱1 082.43.

2. The compound interest earned in 1 year is ₱82.43. The average rate per year at which interest is
earned on the original principal during the year is
82.43
= 0.08243 or 8.243%.
1 000

Compound Interest Formula

 To use the compound interest formula, you will need figures for principal amount, annual interest rate,
time factor and the number of conversion periods. Once you have those, you can go through the process of
calculating compound interest.

The formula for compound interest, including principal sum, is:

( )
n
r
S=P 1+
m

where:
S= the future value of the investment/loan, including interest
P = the principal investment amount (the initial deposit or loan amount)
r = the annual interest rate
m = the number of times that interest is compounded per unit t
t = the time the money is invested or borrowed for
n = interest periods (n=mt )

Note:
For compound interest,
• annually means once per year (m=1).
• semiannually means twice per year (m=2).
• quarterly means 4 times per year (m=4 ).
• monthly means 12 times per year (m=12).
• daily usually means 365 times per year or 366 times per year during a leap year.
Examples:
1. If an amount of ₱5 000.00 is deposited into a savings account at an annual interest rate of 5%,
compounded monthly, find the value of the investment after 10 years.
Solution:
Given: P=5 000 , j=0.05, m=12, t=10 , n= (12 )( 10 ) =120 Solve for: S

( )
n
j
S=P 1+
m

( )
120
0.05
¿ 5 000 1+
12
S ≈ 8 235.05

Thus, the value of the investment after 10 years is ₱8 235.05.

2. What rate converted semiannually will make ₱20 000.00 amount to ₱50 000.00 in 8.5 years?
Solution:
Given: P=20 000 , S=50 000 , m=2, t=8.5 , n=( 2 )( 8.5 )=17 Solve for: j

( )
n
j
S=P 1+
m

( )
17
j
50 000=20 000 1+
2

( )
17
j
2.5= 1+
2
j=2 ( 17√ 2.5−1 )
j ≈ 0.1108 or 11.08%
Therefore, the rate is 11.08%.

3. When will a principal double itself if the interest rate is 14% compounded quarterly?
Solution:
Given: S=2 P , m=4 , j=¿0.14 Solve for: t

( )
n
j
S=P 1+
m

S=P (1+ )
mt
j
m

( ) 2= (1.035 ) log 2=4 t log(1.035)

4t
0.14 log 2
2 P=P 1+ 4t
t=
4 4 log (1.035)
t ≈ 5.0372

LESSON 7.5: Present Value and Discount Compound Interest

To discount an amount S for n conversion periods means to find its present value P on a day which
is n periods before S is due. If we let I be the discount on S, then I =S – P . For convenience in solving

( )
n
j
discount problems, we alter S=P 1+ by solving for P :
m

( )
−n
S j
P= ∨P=S 1+
( )
n
j m
1+
m

Example:
If money can be invested at 4% compounded semiannually, find the present value of ₱10 000.00 due at
1
the end of 4 years.
2
Solution:
Given: S=10 000, j=0.04 , m=2, t=4.5 ,n=(2) ( 4.5 )=9 Solve for: P

( )
−n
j
P=S 1+
m

¿ 10 000 (1+
2 )
−9
0.04

P ≈ 8 367.55
Thus, the present value is ₱8 367.55.

Activity
I. Solve the following problems. Round your answers to the nearest centavo. If the answer is a percent,
express the answer to the nearest hundredth of a percent. Show your complete solution for full credit
and box your final answer.
1. If Mr. Valencia borrowed ₱10 000.00 for 8 months at 8%, what is the total amount he will
owe? (2 pts)
2. A ₱150 000.00 certificate of deposit held for 75 days was worth ₱152 125.00. What interest
rate was earned? Assume a 360-day year. (3 pts)
 3. Suppose you decide to pay off a 9% ₱300 000.00 loan early. The bank tells you that you owe
₱11 170.00 interest. Assuming that the bank uses a 365-day year, for how many days are
you being charged interest? (3 pts)
4. A newborn child receives a ₱500 000.00 gift toward a college education from her
grandparents. How much will the ₱500 000.00 be worth in 17 years if it is invested at 7%
compounded quarterly? (3 pts)
5. Mr. Alano deposits ₱70 000.00 in a savings account. The money is left on deposit for 3 years
earning 5% compounded annually. Calculate the account balance at the end of 3 years. (3
pts)
6. If an investment company pays 6% compounded semiannually, how much should you deposit
now to have ₱100 000.00 5 years from now? (5 pts)
7. Ella borrowed ₱520 000.00 from her friend Gail to pay for remodeling work on his house. She
repaid the loan 10 months later with simple interest at 3%. Gail then invested the proceeds
(original principal plus interest) in a 5-year certificate of deposit paying 3.3% compounded
quarterly. How much will she have at the end of 5 years? (6 pts)
II. Answer the following questions in three to five sentences. (5 pts. each)
1. Why would you rather earn compound interest than simple interest?
2. What are the pros and cons of having a credit card?
3. What are the differences among stocks, bonds, and mutual funds?