Mathematics of Finance

Mathematics of
Finance
• Simple Interest, Compound
Interest, and Annuities
• Stocks, Bonds, and Mutual Funds
Simple Interest, Compound Interest, and
Annuities
Simple Interest
The Simple interest is given by: I = Prt
P = principal; r = interest per year; t = is the number of years.
Ordinary simple interest – we use 360 days per year.
Exact simple interest – we use 365 in a year or 366 days for a leap year.
Future value or maturity value – the total amount paid including the
interest.
F=P+I
•
Example 1:
An employee borrows P60,000 for 7 months at an interest rate of 12% per year.
Find the interest earned and the total amount he has to pay.
Solution:
The interest earned is
I = Prt
= (60,000)(0.12)()
I = P4,200
The total amount to be paid is
F=P+I
= 60,000 + 4,200
F = P64,200
•
Example 2:
The ordinary simple interest charged after 130 days on a loan of P10,200 is
P575. Find the interest rate.
Solution:
Use 360 days per year in computing for the ordinary simple interest. Thus,
I = Prt
575 = 10,200 (r) ()
To solve for: =r

r=
r = .156 or 15.6%
Annuities
•
Compound Interest
Compound interest is computed based on the principal amount and the
total accumulated interest earned.
j = nominal rate; m = number of compounding periods in a year.

= rate per compounding period
mt = number of compounding period
•
Example 3:
A mother invested P100,000 in a mutual fund on the date her first son was born.
If the money is worth 10% compounded semi-annually, how much will the son
receive on his 18th birthday?
Solution
P = 100,000; j = 10%; m = 2 (semi-annually means twice a year); t =18
= 100,000 (1 +
= 100,000 (1 + 0.05
F = P579, 182
•
Example 4:
What is the amount that should be deposited today at 6.5% compounded
quarterly in order to withdraw P200,000 and leave nothing in the fund at the end
of 5 years?
P=
P=
P = P144,883.46
•
Effective interest rate (ER), equivalent to interest rate compounded annually. It can be
used to compare two rates with different compounding periods.
Example 5
If bank 1 advertises its rate as 6.2% compounded monthly, and bank 2 advertises its rate
as 6.3% compounded annually, which rate is better for an investment?
Solution
For bank 1, the effective rate is
= 0.064 or 6.4%
For bank 2, the effective rate is
= 0.063 or 6.3%
Hence, bank 1 has a better interest rate. A higher rate is good for financial investment
Annuities
•
Annuity: Sinking fund and Amortization
An annuity is a series of equal payments made at regular time intervals. It
is also know as a sinking fund which is used for future financial
obligations. An ordinary annuity is one whose payments are made at the
end of each interest period.
A = payment made at the end of each successive period; j = is the interest

rate; m = number of payments per year; and n = is the total number of
periods.
•
Example 6
A house and lot amounting to P3.5M is to be amortized by monthly payments
over 5 years at an annual interest rate of 10%. What is the monthly payment?
3,500,000
3,500,000 = A (47.0654)
A=
A = P74, 364.61
Stocks, Bonds, and Mutual Funds
Stocks are sold to increase a corporation’s capital.

 Stocks represent shares of ownership in a company.
Illustration:
Suppose four people formed a business with each contributing Php1M. If
this amount is equivalent to one share, then each one owns ¼ of the
business.
•Shares
of stock indicate the fractional ownership of a corporation that is
proportional to the total number of shares from all investors.
The investor of these stocks are called stockholders of the corporation.
The profits shared by the stockholders are called dividends which are
usually expressed as a per-share amount.
Example
Compute the dividends a shareholder should receive if he has 80 shares and
a stock is equivalent to P75 per share.
Solution
Total dividends = (80 shares) (
= P6000
•The
dividend yield is computed as the annual dividend divided by the stock
price using the formula
I = Pr
Example
What is the dividend yield rate for a stock that pays an annual dividend of
P150 per share and trades at P3000?
Solution
r = 0.05 or 5%
•Corporation
sell bonds to borrow money from investors called bondholders.
Usually, government agencies issue bonds in the form of treasury bills.
The amount paid to the bond is called the face value or the principal value.
The corporation has to pay the said amount on a particular agreed-upon date called
the maturity date, at a specified rate of interest, called coupon.
To determine the face value PV and the discount D of a treasury bill,
PP = purchase price; PV = principal or face value; r = coupon; and d = number of days

•Example

A treasury bond with a P200,000 principal value has a 4% coupon and a
100-day maturity period. Compute for the bond discount.
Solution
)
200,000)
PP =
PP = 197,802
D = PV – PP
= 200,000 – 197,802
D = P2,198
Stocks, Bonds, and Mutual Funds
•Mutual
fund is an investment trust company whose assets are based
purely om stocks and bonds. This type of company is involved only in the
purchasing of stocks and bonds.
All investments in the mutual fund is called the fund’s portfolio.
The value of a share in a mutual fund is called the net asset value (NAV)
which is obtained by
•Example:

An investment trust company has P500M worth of stocks, P25M worth of
bonds, P10M in cash. The fund’s total liabilities amount to P5M. If there are
8 million outstanding shares, calculate the net asset value of the fund.
Solution

Mathematics of Finance

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Mathematics of

To solve for: =r

j = nominal rate; m = number of compounding periods in a year.

A = payment made at the end of each successive period; j = is the interest

Stocks are sold to increase a corporation’s capital.

PP = purchase price; PV = principal or face value; r = coupon; and d = number of days

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