ECONOM 203 ❖It is earned when a person or organization saves,

invests, or lends money and obtains a return of a larger

MONEY-TIME RELATIONSHIPS amount over time.
AND EQUIVALENCE
From the viewpoint of the borrower:
Interest – is the amount of money paid for the use of

Money-Time Relationships And Equivalence

- refer to the principles governing how money
values change over time due to factors like
interest rates and timing differences between
payments.
- This field forms the foundational concepts for borrowed capital.
understanding financial management and
decision-making processes. For the lender:
Interest – is the income produced by the money which he
INTEREST has lent.
The relationship between interest, principal, and time is
fundamental to determining the future values of ■ Value of interest paid or earned
investments.
Interest = final amount − original amount
The formula
I=Pin ■ Interest rate or rate of return (ROR)
P=initial principal amount
i = interest rate per period interest
n = the number of periods (%) = × 100%
original amount
Origin Of Interests
- Like taxes, interest has existed from the time of
■ Interest period is the time unit of the rate (most
man’s earliest recorded history. Records reveal
common is 1 year).
its existence in Babylon in 2000B.C
■ The term rate of investment (ROI) is used
- In the earliest instances, interest was paid for the
equivalently with ROR in different industries and
use of grain or other commodities that were
settings, especially where large capital funds are
borrowed; it was also paid in the form of grain
committed to engineering-oriented programs.
or other goods.
- History also reveals that the idea of interest
❖From the borrower’s perspective, the term interest
became so well established that a firm of
rate paid is used.
international bankers existed in 575 B.C. with
home offices in Babylon. ❖From the investor’s perspective, the term rate or
- Its income was derived from the high-interest return earned is used.
rates it charged for the use of its money for
financing international trade.
- Interest is not only one of our oldest institutions,
but its uses have suffered little change through
the years.

INTEREST
❖It is paid when a person or organization borrows
money and repays a larger amount over time.
SIMPLE INTEREST
In simple interest, only the original principal bears
interest and the interest to be paid varies directly with
time.

Simple interest is calculated using principal only,

ignoring any interest that had been accrued in preceding
periods.

In practice, simple interest is paid on short-term loans in

which the time of the loan is measured in days.

■ Interest: I = Pin
■ Future worth: F = P + I or F = P + Pin
F = P (1 + in)

where
P = principal or present worth
F=future amount, maturity value
i = interest rate per interest period
n = number of interest periods

ORDINARY SIMPLE INTEREST

Ordinary Simple Interest is computed on the basis of the
banker’s year. ■ A cash flow diagram is the amount of money estimated
for future projects or observed for project events that
1 year = 12 months have taken place.
1 month = 30 days (all months) ■ It is a graphical representation of cash inflows and
1 year = 360 days outflows drawn on a time scale.

EXACT SIMPLE INTEREST
Exact Simple interest is based on the actual number of
days in a year.
- One year is equivalent to 365 days for the
ordinary year, and 366 days for the leap year.
- A leap year is when the month of February is 29
days, and an ordinary year is when February is
28 days.
- Leap year occurs every four years.
❖Cash inflows are all types of receipts, including sales,
revenues, incomes, money from a loan when received
from the lender, and savings generated by project and
business activity. A positive sign indicates a cash
inflow.
❖Cash outflows are all types of costs, including
disbursements, expenses, deposits into retirement or
savings accounts, loan repayments, and taxes caused by
projects and business activity. A negative sign indicates
a cash outflow.

Note:
When simple interest (ordinary or exact) is not
specified in any problem, it is assumed as ordinary.

CASH FLOW
Cash Flow Diagram

■ Cash flow diagrams visually represent income and

expenses over some time interval.
■ The diagram consists of a horizontal line with markers
at a series of time intervals.
■ At appropriate times, expenses and costs are shown in
the diagram.

COMPOUND INTEREST

 If the interest is calculated more than once per year,

then itis called “compound interest”.
