ACI/ FINANCIAL MARKETS

AND DEALERS COURSE

UNIT 1
Basic Interest Rates Calculations
2nd October 2020

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 Financial market
• Participants to understand and appreciate Financial
markets there in need to understand the dynamics of basic
interest rate calculations.
• Basic interest rate calculations unit covers:
i. Interest rate and types
ii. time value of money and its variables
iii. simple and compound interest
iv. Day conventions and benchmark rates
v. Yield curve
vi. Introduction to bond market

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 Financial market (FM)
• Market in which financial assets are created and traded.
• Principal task of FM is to facilitate the movement of excess funds
from those economic segments in surplus to those that experience a
shortage. This is supported by financial institutions.
• FM Players:
i. Brokers – commission agents
ii. Dealers – match buyers and sellers of assets
iii. Investment banks –assist in initial sale of newly issued securities
iv. Financial institutions- engage in financial asset transformation.
• FM types
i. Auction markets – Brokers
ii. Over The Counter (OTC) – dealers
iii. Organised exchanges- OTC and Auction
iv. f
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 Financial market
• FM plays a crucial role in allocation of resources in the
country’s economy
• FM functions:
i. Borrowing and lending
ii. Price determination
iii. Information aggregation and coordination
iv. Risk sharing
v. Asset liquidity and cost efficiency
• FM subdivisions
i. Primary and secondary markets
ii. Cash money and capital markets
iii. Foreign exchange markets
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 Time value of Money (TVM)
• Fundamental concepts in finance is that money has a “time
value” dollar today is worth more than a dollar tomorrow.
• Time value of money concepts, terminology and their application
in the financial markets must be understood
• Biggest obstacle in correctly solving time value for money
problems is the identification of the cash flows and the timing of
the variables:
i. Rates (r)- growth rate of the money
ii. Time/ periods (t) – life of the investment
iii. Present value (pv) – 1st cash flow
iv. Future value (fv) – or payment amount or last cash flow
• Interest rates are expressed as a percentage (%) of the amount
you borrow or save over a year.
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 Time value of Money (TVM)
• Fundamental concepts in finance is that money has a “time
value” dollar today is worth more than a dollar tomorrow.
• Time value of money concepts, terminology and their application
in the financial markets must be understood.
• The exact time value of money is determined by opportunity Cost
and interest rates.
• Value for money is systematic process of understanding whether
an investment (money, time or other resources) represents good
value
• The Time Value of Money is an important concept to investors “a
dollar on hand today is worth more than a dollar promised in the
future”.
• Interest is paid to savers by banks and Interest is charged to
borrowers of money (interest is a rent on money)
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 Time value of Money (TVM)
1. Interest rate – price paid for borrowing (using) money,
expressed as % over a period of time which reflects the rate of
exchange of present consumption for future consumption.
Example borrowing money from the bank to boost your
business (asset purchases).
• example.
i. lend $1,000 for a year you receive $1,050.
ii. you invest $1,000 (the present value) for 1 year at a 5%
interest rate , year end you receive $1,050 (the future value)..
iii. Investment of £1,000 above attracted a 5% interest rate, to give
£1,050 a year end

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 Time value for Money (TVM)
• 5 major components of Time Value
i. Rates(i)
ii. Time/ periods (t)
iii. Present value (pv)
iv. Future value (fv)
• pv – present value/1st cash flow used to derive fv
• Interest rates expressed as a percentage (%) of
the amount you borrow or save over a year

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 Simple interest formula
 SIMPLE INTEREST.xlsx

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 Finance concept of Time value for Money
•  

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 Simple interest calculations
•  
• present value ), , and ,
•

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 INTEREST RATE TYPES
1. the nominal interest rate
2. the effective rate – average rate
3. the real interest rate – adjustments made.
• borrowing (credit card, loan, or mortgage) rate
types:
1. Fixed Rate Interest – does not vary along the
period
2. Variable Rate Interest- varies along the period

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 INTEREST RATE TYPES
 An interest rate takes two forms: 
1. nominal interest rateis a rate used to
calculate interest payments on an investment
and does not take into account the
compounding period.
• The effective interest rate does take the
compounding period into account and thus a
more accurate measure of interest charges.

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 Fixed Vs Variable Interest rate
• A fixed rate loan is “An interest rate that will remain at
a predetermined rate for the entire term of the loan, no
matter what market interest rates do. This will result in
payments remaining the same over the entire term.” 
• Variable Interest Rate: “An interest rate that moves up
and down based on the changes of an underlying
interest rate index.
• Fixed interest rate are generally tied to longer-term.

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 REAL Vs NOMINAL INTEREST
• Nominal
  interest rate
 Interest amount payable @ rate of 5% for investing UGX
1,000,000 =

 Real interest rate

 Adjustment of inflation is taken into account.
 Assume annual inflation rate is @ 3%

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