BCO126 Mathematics of Finance

3 ECTS
SPRING SEMESTER 2022
(week 5)

Dr. Daniel Biggemann

Review
Time Value of Money
• One dollar is worth more today than in the future.
• Value changes because it can be invested.
• Interest rate: Present → Future
• Discount rate: Future → Present (or Present → Past)
• Represented by the timeline
• Elements of a project
• Principal
• Interest Rate
• Cashflow
• Return
Review
Simple Interest Rate
• Interest earned

• Accumulated amount:

• Straight line
• Ordinary or exact year (360 or 365 days)
• Number of days between dates
• Discount factor

• Fixed payments (amortization)

• The interest depends ONLY on the nominal rate
Review
Compound interest rate
• Principal reinverted (accumulated value grows faster than simple
interest rate)
• Potential curve
• Nominal rate (
• Periodicity of capitalization (payments) .
• Effective rate
• Accumulated value after a time

• Discount factor
 Compound Interest – excercises
(7)   Which of the following forms of payment is most convenient for the
buyer of a land, if the compound interest rate is 36% per annum
compounded monthly?
a) $890 000 cash.
b) 3 equal quarterly payments of $334 300 beginning today.
c) $200 000 cash and 3 equal semi-annual payments of
$280 000 starting in 2 months.
 Compound Interest – excercises
(7)   Which of the following forms of payment is most convenient for the
buyer of a land, if the compound interest rate is 36% per annum
compounded monthly?
a) $890 000 cash.
b) 3 equal quarterly payments of $334 300 beginning today.
c) $200 000 cash and 3 equal semi-annual payments of
$280 000 starting in 2 months.

Solution
All the values MUST be expressed at the same date in order to be
compared.

a) The present value of the payment is:

 Excercises
(7)   Which of the following forms of payment is most convenient for the
buyer of a land, if the compound interest rate is 36% per annum
compounded monthly?
a) $890 000 cash.
b) 3 equal quarterly payments of $334 300 beginning today.
c) $200 000 cash and 3 equal semi-annual payments of $280 000
starting in 2 months.
𝑃𝑉 𝑏
b)
 Compound Interest – excercises
(7)   Which of the following forms of payment is most convenient for the
buyer of a land, if the compound interest rate is 36% per annum
compounded monthly?
a) $890 000 cash.
b) 3 equal quarterly payments of $334 300 beginning today.
c) $200 000 cash and 3 equal semi-annual payments of
$280 000 starting in 2 months.
𝑃𝑉 𝑐
c)

−2 −8 −14
𝑃𝑉 𝑐 =200 0 00+280 0 00 ( 1+0.03 ) +280 0 00 (1+ 0.03 ) +280 000 ( 1+ 0.03 )
 Compound Interest – excercises
(7)   Which of the following forms of payment is most convenient for the
buyer of a land, if the compound interest rate is 36% per annum
compounded monthly?
a) $890 000 cash.
b) 3 equal quarterly payments of $334 300 beginning today.
c) $200 000 cash and 3 equal semi-annual payments of
$280 000 starting in 2 months.

Solution If we add WRONGLY the payments @ different dates

Comparing the results:

a) a)
b)
b)
 Compound Interest – excercises
(8) Which decision is more profitable: a) making a deposit in a financial
certificate that pays 17.8% compounded biweekly or b) investing in a
business that guarantees that the amount invested will double in 4
years?
 Compound Interest – excercises
(8) Which decision is more profitable: a) making a deposit in a financial
certificate that pays 17.8% compounded biweekly or b) investing in a
business that guarantees that the amount invested will double in 4
years?

Solution
There are two ways to solve the excercise: comparing interest rates and
comparing amounts.
Comparing interest rates:
a)
b) Let´s remember:

[( ) ]
1
2𝑃
𝑗𝑚 =24 4 ∙24
−1 =0.1739=𝟏𝟕 . 𝟑𝟗 % <𝟏𝟕 . 𝟖 %
𝑃
 Compound Interest – excercises
(8) Which decision is more profitable: a) making a deposit in a financial
certificate that pays 17.8% compounded biweekly or b) investing in a
business that guarantees that the amount invested will double in 4
years?

Solution
Comparing amounts: (let´s suppose an amount of $10 000)
a)

b) In this case, A should be only $20 000, beceuse doubles the

amount invested.

The option a) is the best one.

 Compound Interest – excercises
(9) Mr. Müller wishes to make a fixed term deposit and, as he is a
customer of two banks, he hesitates to invest in one or the other. If
Bank Alpha offers to pay him 15% compounded monthly and Bank
Beta offers to pay him 14.85% but compounded daily, determine
which bank would be more profitable for him, if both have the same
level of risk.
 Compound Interest – excercises
(9) Mr. Müller wishes to make a fixed term deposit and, as he is a
customer of two banks, he hesitates to invest in one or the other. If
Bank Alpha offers to pay him 15% compounded monthly and Bank
Beta offers to pay him 14.85% but compounded daily, determine
which bank would be more profitable for him, if both have the same
level of risk.

Solution 1
Bank Alpha:
Bank Beta:

Then, Bank Alpha pays better than Bank Beta!

 Compound Interest – excercises
(9) Mr. Müller wishes to make a fixed term deposit and, as he is a
customer of two banks, he hesitates to invest in one or the other. If
Bank Alpha offers to pay him 15% compounded monthly and Bank
Beta offers to pay him 14.85% but compounded daily, determine
which bank would be more profitable for him, if both have the same
level of risk.

Solution 2
We can compare both interest rates. To do it, we must have both at the
same frequency.
Two equivalent interest rates, but with different frequency have the same
A and P.
 Compound Interest – excercises
(9) Mr. Müller wishes to make a fixed term deposit and, as he is a
customer of two banks, he hesitates to invest in one or the other. If
Bank Alpha offers to pay him 15% compounded monthly and Bank
Beta offers to pay him 14.85% but compounded daily, determine
which bank would be more profitable for him, if both have the same
level of risk.

Solution 2
Replacing values, we have:

Which is better than the interest rate offered by the Bank Beta. So, the
Bank Alpha is better to invest!!
 Compound Interest – excercises
(10) A woman borrowed $78 000 with interest at 24% per annum
compounded monthly, committing to pay off the debt in 3
payments: $18 000 after 1 and a half months, $30 000 within 4
months and a final payment after 8 months. Determine the amount
of the third payment and the total interest paid.
 Compound Interest – excercises
(10) A woman borrowed $78 000 with interest at 24% per annum
compounded monthly, committing to pay off the debt in 3
payments: $18 000 after 1 and a half months, $30 000 within 4
months and a final payment after 8 months. Determine the amount
of the third payment and the total interest paid.

Solution

FD

months
 Compound Interest – excercises

FD

months

Let´s calculate all the values in 8 months.

 Compound Interest – excercises
(11) A woman borrowed $78 000 with interest at 24% per annum
compounded monthly, committing to pay off the debt in 3
payments: $18 000 after 1 and a half months, $30 000 within 4
months and a final payment after 8 months. Determine the
amount of the third payment and the total interest paid.
…Solve the same problem, but calculating all at 4th month.
 Compound Interest – excercises
(11) A woman borrowed $78 000 with interest at 24% per annum
compounded monthly, committing to pay off the debt in 3
payments: $18 000 after 1 and a half months, $30 000 within 4
months and a final payment after 8 months. Determine the
amount of the third payment and the total interest paid.
…Solve the same problem, but calculating all at 4th month.

Solution
FD

months
 Compound Interest – excercises
FD

months

Then, the interest:

 Compound Interest – excercises
(12) A man has a debt that he must pay off in two payments: $30 000 on
June 12th and $45 000 on December 10th. If the first payment was
not made on the agreed date, what amount should be paid on
November 5th to completely pay off the debt, taking into account that
the agreed interest rate was 54% per annum compounded daily?
 Compound Interest – excercises
(12) A man has a debt that he must pay off in two payments: $30 000 on
June 12th and $45 000 on December 10th. If the first payment was
not made on the agreed date, what amount should be paid on
November 5th to completely pay off the debt, taking into account that
the agreed interest rate was 54% per annum compounded daily?

Solution

FD
 Compound Interest – excercises

FD

Calculating the values of $30 000 and $45 000 on November 5th:
 Compound Interest – excercises
(13) A man made an initial deposit of $25 000 into a bank account that
pays 0.75% biweekly. Two and six months later he made 2 equal
cash withdrawals, 9 months later he deposited $20 000 and one
year later he saw that the total balance of the account was
$24 894.97. Calculate the value of the 2 equal withdrawals.
 Compound Interest – excercises
(13) A man made an initial deposit of $25 000 into a bank account that
pays 0.75% biweekly. Two and six months later he made 2 equal
cash withdrawals, 9 months later he deposited $20 000 and one
year later he saw that the total balance of the account was
$24 894.97. Calculate the value of the 2 equal withdrawals.

Solution
FD

months
 Compound Interest – excercises
FD

months

12 20 000 8 24 894.97
25 000 ( 1+0.0075 ) + = 𝑋 ( 1+0.0075 ) + 𝑋 +
( 1+ 0.0075 )6 (1+ 00.75 )12

Each withdrawal X was had an amount:

 Compound Interest – excercises
(14) A debt originally payable in 2 equal payments of $180 000, due in
4th and 8th months, is settled in 4 semi-annual payments, starting to
be paid immediately. If the 2nd and 3rd payments are equal to twice
the first, and the fourth payment is three times the first, determine
the amount of the payments, if the interest rate is 18% per annum,
compounded bimonthly.
 Compound Interest – excercises
(14) A debt originally payable in 2 equal payments of $180 000, due in
4th and 8th months, is settled in 4 semi-annual payments, starting to
be paid immediately. If the 2nd and 3rd payments are equal to twice
the first, and the fourth payment is three times the first, determine
the amount of the payments, if the interest rate is 18% per annum,
compounded bimonthly.

Solution
FD

months
 Compound Interest – excercises

FD

months

Then, we have:
 Rate of Return
The Rate of Return ( is a measurement of the loss or profit of an
investment along the time.

The annualized RoR (n years):

 Summary

• What is the definition of the compound interest rate?

• How do you calculate the Future Value with compound interest rates?
• How do you calculate the Present Value with compound interest
rates?
• How do you calculate the Future Value over multiple periods with
compound interest?
• How do you calculate the Rate of Return with a  compound interest
rate?