0 - W5-L5 Chapter 1 - Simple Interest

Week 5.
L5
Chapter one
Simple interest and simple
discount
Copyright © 2013 McGraw-Hill Australia Pty Ltd

Zima, Tannous, Brown, Kopp, Mathematics of Finance, 1e 1-1
Learning objectives
1.1 Calculate the simple interest earned.
1.2 Calculate the accumulated value.
1.3 Calculate the number of days between two
dates.
1.4 Calculate the present value.
1.5 Calculate an equivalent single payment.
1.6 Determine repayment of loan through partial
payments.
1.7 Calculate interest payable at the start of an
investment period.
1.8 Apply your knowledge of simple interest .
Simple interest
continued
Simple interest

Simple interest
I  Pr t I=?
90 P = 10 000
r = 5.9% p.a.
t
365
0 90 days
90
I  10000  0.059 
365
I  $147.48

Accumulated value
• Accumulated value (Future Value)
S = P + I (substitute I = P  r  t for I)
S = P + P  r  t = P(1 + r  t)
• Example: Miss Ling deposits $10 000 in a 90-day
term deposit earning 5.9% per annum. How much
will she have at the end?
r = 5.9% p.a.
S  P  (1  r  t ) P = 10 000 S=?
90 0 90 days
S  10 000  (1  0.059  )  $10 145.48 or
365
S  10 000  145.48  $10 145.48

Number of days
• When calculating the number of days,
the end date is subtracted from the
starting date.
– This technique includes the last date but
not the first.
– If the first date is also needed then 1 is
added at the end.
continued
Number of days
7
a ) I  15 000  0.07   $ 612.50
12
S  15 000  612.50  $15 612.50
207
b) I  15 000  0.07   $ 595.48
365
S  15 000  595.48  $15 ,595.48

Number of days
• A demand loan permits the borrower
and the lender to repay full or partial
payment at any time.
– Interest is based on the unpaid balance.
– It is usually payable monthly.
– Interest rate usually variable.
– Example 8 page 8 of the textbook

Present value
• Present value is equal to the future
amount discounted back at the simple
interest rate:
r
P = S(1 + rt)–1 S
S
P  S (1  rt )1
1  rt 0 t
continued
Present value
• Example: Jennifer wishes to have $1000 in 8
months’ time. If she can earn 6% per annum
simple interest, how much does she need to
invest on 15 September? How much interest
does she earn? r = 6% p.a.
31 times 8 = 248 P n = 242 days S = 1000

Less (1 day of Sep + 1 day of
Nov +3 days of Feb + 1 day of 15 Sep 15 May
April )
242 1
P 248
 1000
– 6 =242
[1  0.06( )]  $961.74
365
I  S  P  (1000  961.74)  $38.26

Present value
• A promissory note is a written promise by a
debtor to pay to the payee of the note, a sum
of money on a specified date.
– They typically have a duration of less than 1 year.
– Simple interest is used in any calculation.
– Two types of promissory note:
 Non-interest bearing note: S = face value
 Interest bearing note: S = face value  (1+ rt)
• Treasury Notes are a short-term debt
instrument issued by the federal government.
• Example 3 and 4 page 12 and 13

See you tomorrow
@8am sharp but
before you go take this
triangle with you……..

Equations of value
• Money has time value.
• Two sets of payments are equivalent at a
given simple interest rate if the dated values of
the sets, on any common date, are equal.
• An equation stating that the dated values, on a
common date, of two sets of payments are
equal is called an equation of value or an
equation of equivalence.
• The common date used is called the focal
date, the comparison date or the valuation
date.
continued
Equations of value

Equations of value
• Example: Debts of $500 due 20 days ago and $400
due in 50 days are to be settled by a payment of
$600 now and a final payment 90 days from now.
Determine the value of the final payment at a simple
interest rate of 11% per annum with a focal date at
the present.
20 days 50 days
debts: 500 400 S=?
-20 0 50 90
payments: 600 X
90 days
focal date
90 −1 20 50 −1
𝑋[1 + ሺ0.11ሻ൬ ൰ ] + 600 = 500 ൤1 + ሺ0.11ሻ൬ ൰ ൨+ 400[1 + (0.11)( )]
365 365 365
𝑋 =ሶ$305.13

Partial payments
• Financial obligations are sometimes
liquidated by a series of partial payments
during the term of obligation.
• Two common methods used:
– Declining balance method—the interest on the
unpaid balance of the debt is computed each time
a partial payment is made. Example 1 page 22
– Merchant’s rule—the entire debt and each partial
payment earn interest to the final settlement
dates. Example 2 page 24

Simple discount calculation
• Calculation of present values over durations of
less than 1 year is sometimes based on a
simple discount rate.
– The annual simple discount rate d is the ratio of the
discount D for the year to the amount S on which
the discount is given.
– Simple discount is:
D = Sdt = FVdt
– Present value with simple discount:
P=S-D
P = S − Sdt
P = S(1 − dt)
continued
• Example: A person takes out a discounted loan with a
face value of $500 for 6 months from a lender who
charges a 9½% per annum simple discount rate.
a) What is the discount and how much money does
the borrower receive?
P = S(1 − dt) = 500[1 − (0.095)(½)] = $476.25
b) What size loan should the borrower ask for if he
wants to receive $500 cash?
S = P(1 − dt)−1 = 500[1 − (0.095)(½)]−1 = $524.93
continued

• Example: If $1200 is the present value of
$1260 due at the end of 9 months determine:
a) the annual simple interest rate
I 60
r   6.67%
9
Pt 1200( )
12
b) the annual simple discount rate

D 60
r   6.35%
9
St 1260( )
12

Valuation of short-term debt
• Promissory notes are occasionally sold
based on simple discount from the maturity
value.
• Example: On 10 August, Smith borrows $4000 from
Jones and gives Jones a promissory note at a r =
10% p.a. with a maturity date of 4 February in the
following year.
– Brown buys the note from Jones on 3 November,
based on a simple discount rate of 11%.
– Determine Brown’s purchase price and determine
what rate of simple interest Brown earns.
continued
Valuation of short-term debt
– Determine Brown’s purchase price and
determine what rate of simple interest Brown 178 days at r=10%
earns $4000
S=?
Aug 10 Nov 3 Feb 4

Proceeds? 93 days d=11%
178
Maturity value, S  4000  [1  0.10( )]  $4195.07
365
93
Proceeds on November 3, P  S (1  dt )  4195[1  0.11( )]  $4077.49
365
Brown earns I  4195.07  4077.49  $117.58 over 93 days
I 117.58
r   0.11317499  11.32% p.a.
Pt 4077.49( 93
)
365

Summary
• Accumulated value of P and discount value of S at
the end of t years:
S = P(1 + rt) with r = simple interest rate
P = S(1 + rt)−1 with r = simple interest rate
• Discounted value of S and accumulated value of P at
a simple discount rate:
P = S(1 − dt) with d = simple discount rate
S= P(1 − dt)−1 with d = simple discount rate
• Equivalence of dated values at simple interest rate r:
X due on a given date is equivalent to Y due t years
later if
Y = X(1 + rt) or X = Y(1 + rt)−1


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Week 5.

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– Example 8 page 8 of the textbook

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31 times 8 = 248 P n = 242 days S = 1000

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b) the annual simple discount rate

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Aug 10 Nov 3 Feb 4

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