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AMORTIZATION

yIs a means of repaying a debt by a

series of equal payments at equal time interval. The periodic payments from an annuity in which the present value is the principal of an interest-bearing debt.

AMORTIZATION
y Formulas:

where A = principal, R = periodic payment, i = interest per period and n = total number of payment periods

A = R [1 (1 + i)-n / i] and R = Ai / 1 (1 + i)-n

AMORTIZATION
y Example: y An obligation of PhP y Given Data:

21,000 with interest of 8% compounded semiannually must be paid at the end of every 6 months for 4 years. a) Find the size of periodic payment. b) Find the remaining liability just after making the 5th payment. c) Prepare the amortization table.

A = PhP 21,000 m=2 i = 0.04 j = 8% t = 4 years n=8

Solution: R = Ai / 1 (1 + i)-n = 21,000 (0.04) / 1 (1.04)-8 = 3,119.08 = R [1 (1 + i)-n / i] = 3,119.08 [1 (1.04)-3 / 0.04 = 8,655.73

- The remaining liability after the 5th payment is the present value of the remaining periodic payments.

c) Amortization Table Period 1 2 3 4 5 6 7 8 Total Balance 21,000.00 18,720.92 16,350.68 13,885.63 11,321.98 8,655.78 5,882.93 2,999.16 Payment 3,119.08 3,119.08 3,119.08 3,119.08 3,119.08 3,119.08 3,119.08 3,119.08 24,952.64 Interest Paid 840.00 748.84 654.03 555.43 542.88 346.23 235.72 119.97 3,953.10 Payment for Principal 2,279.00 2,370.24 2,465.05 2,563.65 2,666.20 2,772.85 2,883.76 2,999.11 21,000.00*

* The actual value is PhP 20,999.94. This is due to rounding error.

AMORTIZATION
y Student Activity # 1: Atsumi borrows a

certain amount to buy a bicycle at 12% compounded monthly. The debt will be discharged by paying PhP 400 monthly for 1 year. a) What is the cash value of the bicycle? b) How much of her 7th payment is interest and how much goes to repayment of principal? c) Construct the amortization table.

SINKING FUND
y Refers to a fund created by making

periodic deposits to anticipate the need of paying a large amount of money at some future dates. y The amount of fund at any time is the sum of an ordinary annuity accumulated by equal periodic payments at equal intervals of time, and the amount of interest earned.

SINKING FUND
y A sinking fund schedule illustrates how the

fund accumulates every payment period, and to determine the amount in the fund at any given time, the following geometric progression formulas for ordinary annuity are used.

y SO = R [(1 + i)n 1] / i y R = SO(i) / (1 + i)n - 1

SINKING FUND
y Example y A fund is created by making y Given:

equal monthly deposits of PhP 3,000.00 at 9% converted monthly. y Determine the sum after half year. y What is the amount in the fund after the 4th deposit? y Construct the sinking fund schedule for a 6-month period.

R = 3,000 j = 9% or 0.09 m = 12
y Solution:

SO = R [(1 + i)n 1] / i = 3,000 [(1.0075)6 1] / 0.0075 = 18,340.89 * n = 4, SO = 12,135.66

Sinking fund schedule


Number of Payment Periodic Deposit Interest of Fund Increase in Fund Amount in Fund

1 2 3 4 5 6

3,000 3,000 3,000 3,000 3,000 3,000

0 22.50 45.17 68.01 91.02 114.20

3,000.00 3,022.50 3,045.17 3,068.01 3,091.02 3,114.20

3,000.00 6,022.50 9,067.67 12,135.68 15,226.70 18,340.90

y Student Activity # 2: Three years from

now, Mr. Tan needs PhP 30,000.00 to liquidate a certain debt, at 6% converted semi-annually. y How much must he deposit at the end of every 6 months to provide for the payment of the debt? y Prepare a sinking fund table showing the growth of the fund for 3 years.

It is a written contract by a debtor to pay a final redemption value on an indicated redemption date, or maturity date, and to pay a certain sum Face value/ par value is the borrowed principal and describes the payments as periodic payments of interest at a specified nominal rate called the bond rate. A small dated coupon is attached to the bond corresponding to each payment. Thus, a coupon is a contract to pay on a corresponding date. The bond owner will detach each coupon when it becomes a due. This is then presented for payment through the bank. The payments is called coupon annuity. A bond is named after its value and bond rate.

BONDS
1.Bond Price on a Coupon Date - is when a coupon of a bond becomes due - A bond can be sold at any time and if it is sold on a coupon date, the seller gets the coupon which is already due. 2. Premium Equation - The premium or discount in the purchase of a bond can be computed even without first computing the price. 3. Amortizing a Premium - If the price of a bond is greater than the redemption value, we say that the bond is bought at a premium where the price redemption value as the premium being amortized by the coupon payments. 4. Accumulation of a Discount - The bookkeeping methods of adding the unpaid interest to the value of the bond.

BONDS
5. Price of Bonds for Sale - In buying or selling of

bonds, what is most considered is the coupon payment as being earned or growing continuously during the corresponding period although payment thereof is due at the end of the period. - Prices of bond are controlled by the law of supply and demand. Considering that bonds may be sold at any date.

6. Flat Price between Interest Dates - To find the flat price P and the and interest price q of a bond on a day between successive interest dates A and i to yield the investment rate i, we have to 1) Compute the flat price P1 of the bond to yield the rate i at A. 2) Add to P1 the simple interest on P1 at the rate i for the time from A to B to obtain the flat price P at B to yield the rate i. 3) Subtract the accrued interest at i on day B from P to find the andinterest-price q of the bond at B to yield the rate i.

BONDS
yStudent Activity # 3: Construct

a formula and the sequence of the solution of the flat price between interest dates through the given deadlines. Use symbols only.

BONDS
7. Approximate Bond Yield

- compute the average invested capital (V + Q / 2) - compute the total interest received by investor in the n years from 1 or 2 and divide by n to find the average interest per year - An estimated yield represented by J is: J = Average Annual Interest / Average Investment - Example: A 1,000, 6% bond will be redeemed at the end of 10 years. Estimate the investors yield for buying the bond when it is quoted at 85 and accrued interest.

Solution: a. The book value of the bond changes from 850 to 1,000 due to the accumulation of the discount (85 means 85% of 1,000 = 850) b. The average invested capital is: 850 + 1,000 / 2 = 925 c. The discount on the selling date is: 1,000 850 = 150 d. The total of coupon payments in 10 years is: 1,000 (0.06) x 10 years = 600 e. Total interest in 10 years is: 600 + 150 = 750 f. Average annual interest is: 750 / 10 = 75 g. Approximate yield is: 75 / 925 = 0.0811 or 8.11%

BONDS
8. Valuation of Various Contracts a. Serial Issue bonds which are redeemed on installment basis. b. Serial Bond is one whose face value is redeemable in installments with interest payable periodically as it becomes due on outstanding principal. It is common in the sale of real state. It is essentially composed of several bonds combined in one contract. On any date, the flat price of a serial bond issue is the sum of the corresponding prices of all bonds of the issue still unredeemed. c. Annuity Bond a contract promising the payment of an annuity whose present value is H at the bond rate. When H and bond rate are given, the periodic payment R of the bond can be computed. At any given date, the price of the annuity bond can be obtained by computing the present value of the future payments of the bond at the investor s interest rate.