Financial Mathematics Lesson #1: Simple Interest and Compound Interest GD This unit is required for students and teachers following the WNCP curriculum for Foundations of Mathematics Grade 12. It is not required for students and teachers following the Alberta version of the curriculum, but could be included for completeness or enrichment Investing Money If you deposit money in a financial institution, such as bank, you are in effect lending money to the bani. In exchange. the bank pays you interest. There are two types of interest simple interest and compound interest. Simple Interest ‘Simple interest is usually applicable to short term investments of one year or less o¢ to leng teem investments where the annual interest is paid to the investor end not reinvested, a) If you invest $500, earning interest at 2 rate of 6% per year, how much interest ‘yrould you ear ia i) one year? ii) half a year? ii) one month? b) Iris the annual interest rate (expressed as a decimal) and $P is the initial investment, calculate how much interest would be earned in i) one year ii) half ayear li) + years ‘The formula to calculate simple interest is | I'= Prt where T represents the amount of intexest represents the principal (the initial investment) ‘represents the annual rate of interest - expressed as 2 decimal ¢ represents the time in years for which the meney is invested CasEeat | Millie invests in $2 350 at 7% per year for six months. Calculate, after six months, a) the simple interest on Millie's investment 1b) the value of Millie's investment Compound Interest In simple interest, the principal atthe beginning of the second year is the same as the principal at the beginning of the first year. In compound interest, the interest cared during the first year is added to the original principal to form a new principal To understand the comparison between simple interest and compound interest, do the investigation on the next teee pages.Exploring Simple Interest and Compound Interest A bank offers two types of savings bond: + “Regular Savings Bon ‘hich pays simple interest at 9% p.a. (per year, or per annum) + “Compound Savings Bond”, which pays interest at 9% p.a., compounded annually. Consider an initial investment of $15 000 in each bond, End of Year| Amount ($) Simple Interest 1 16 350 a) The simple interest each year 2 17700 is 9% of $15 000 = 3 19050 4 20 400 b) Complete the table, which gives the value of the bond = at the end of each of the first 8 years. 5 21750 6 a 8 ‘ompound Interest ©) Complete the following to determine the compound interest and the value of the bond. End of Year 1: Value of Bond = Principal + Interest = 15 000 + 15 000(0.09) 15 000(1.09) End of Year2: Value of Bond = Principal + Interest, 5 000(1.09)(1 + 0.09) = 15 000(1.09)(1.09) = 15 000(1.09)* of Ye Value of Bond = Principal + Interest 5.000(1+0.09) factor our 15 000 000(1.09) + 15 000(1.09)(0.09) 5 000(1.09)" + 15 000(1.09)"(0.09) 5.000(1.09)°(1 + 0.09) factor out 15 000(1.09) factor out 15 000(1.09)*) The value for the bond at the end of each year is 1.09 times the value at the end of the previous year. Complete the table below. End of Year | Value of Bond | Amount ($) 1 15 000(1.09) 16 350.00 2 15 0001.09)" | 17821.30 3 15 000(1.09)* 19425.44 4 3 6 7 8 n ‘The Value at the end of n years is 15 000(1.09)" Plot the data from the simple interest ‘and compound interest tables. Do not join the points. ‘The graph shows that the simple interest bond is growing in a linear pattern and the compound interest bond is erowing more quickly, or exponentially. ‘The final amount, A, can be written as Sa poH an exponential function of the number Value of years, n, in the form A = ab”. * State the values of a and b and write the function in this form. + How do the values of a and b relate to the scenario in this question?g) The difference between exponential growth and linear growth is more apparent if we extend the graph in f) to more than 20 years. Amount ($4) 100-080 0 5 10 15 20 Number of Years. Use the compound interest graph to estimate the number of years it would take for the initial investment of $15 000 to increase in value to i) $50 000 ii) $100 000 h) Consider an investment of $30 000 compounded annually at 5% pa ‘Write an exponential function which will represent the final amount $A after n years i) Consider an investment of $750 compounded annually at 3.5% p.a. ‘Write an exponential function which will represent the final amount $A after n years j) In general, if the final amount (or the value of the bond), P = the principal (the initial investment), the annual interest rate, and = the number of years, we have the formula: A=CenEe Cenke Compound Interest Formula Where Interest is Compounded Annually In the previous exploration. interest was compounded on an annual basis. In practice. compounding can take place over any period of time, ¢.2. semi-anaually, monthly, daily, continuously. ete In this lesson, we will focus on interest that is compounded annually. ‘The formule that can be used to calculate compound interest where the interest is compounded on an annual basis is an exponential function of the form y = ab* A=P(+i" where represents the final amount represents the principal (cr initial investment) represents the annual interest rate represents the number of years, spe $4 000 is invested in « 3-year GIC, compounded yeasly at «rate of 3.5 a) Identify values for P.i, and n. b) Determine the value of the investment at the end of the term. Reina has invested $8 000 in 2 5-year bond, compounded annually at a rate of 3.2% per annum, Determine the interest eamed at the end of the 5-year penodAmiber Lynn invested $8 000 in an investment for 5 years compounded annually ata rate of 7.25% per yeas, a) Determine the value of her investment at the end of the term. 1b) Calculate the profit made on her investment ©) Suppose that Amber Lynn bas nt decided how Tong she will kep the investment Ee? Etepeeseat he munberot years har ermoaey 6 vested? ‘Write an equation of the form y = ab* to represent her balance after x years 4) Graph the equation in part c) with the window x [, 10, 1] 3°18000, 18000, 1000), 4) What do the numbers on the x-axis represent? ii) What do the numbers on the y-axis represent? e) Amber Lynn wants to know which of the following options will increase her investment + increasing bir initial investment by $500. or ‘finding an investment with an anriual interest rate of 8%. For each of these two scenarios, write an equation to represent her balance after x years. ‘Initial investment of $8500 Interest rate of 8% £) Grapia the two equations on the same axes as your graph from part d). 2) Describe the differences in the graphs 1h) If Amber Lynn wants to cash out her investment after 5 years, which is the better option? i) If Amber Lynn wants to cash out her investment after 10 years, Which is the better option? Complete Assignment Questions #1 - #7Using TVM to Solve Annual Compound Interest Problems Consider Class Ex. #4: “ Amber Lyna invested $8 000 in an investment for 5 years compourded annually at arate of 7 25% per year. Determine the value of her investment atthe end of the term” Using TVM Solver Determine the value of the investment at the end of the term using TVM Solves, 1. Access the TVM Solver by pressing | APPS ][ 1 ][ 1 ][ ENTER A screen similar to the one shown will appear "N represents the total number of payment periods. 1e represents the annual interest rate, PV represents the present value, or inital value (see note below) ME sets fe nro ance (es Gate Oso, FV represents the future value (see step 3 below). PAY represents the number of payments per year (see note below). C/¥ represents the number of compounding periods per year. Bat: HHMI] BEGINew: exp BEGIN represents de ming of the paymens. 2. Enter the given values using the [ ENTER ] ce arow key after each entry. (This vale changes based on the compounding period ) 200 «see the reg elow as why thsi anegatre value) ( Since no additional payments are made after initial investment ) ( See sten 3 below.) (Seenste below) I BEGIN( Adsume the defaak, END, unless otherwise stated) For the TI-83/84 series Financial functions, take note of the following points: « cash received is a positive value (money entering your “pocket”) «cash paid is a negative value (money leaving your “pocket”) + PAY represents the aumber of payments (PMT) made to the investmeat or loan. fo additional payments are made to the investment or loan. then enter this value so that itis equal to the C/Y value. The Th calculator will not accept 0 for PY (which it should for this type of question, because no additional payments were made into the investment) For questions with no payments, make P/Y the same as the C/Y value ‘The amount $8000 is entered as a negative value because it is the initial principal that has been paid from you to the financial mstination 3. The final value of the bond is represented by FV. Although FV is he 0 not known at this ie, the calculater will nat proceed unless a a value is entered - we have used 0. To find the final value of the 4 PUST 352. 1074 bond, place the cursor over the Value of FV and then press Boye ALPHA |[ ENTER |. An indicater square onthe left of FV _PIT#Iaill BESIN ‘ndicales that the futire value has ben determined.Rule of 72 ‘The Rule of 72 determines the approximate time taken for money to double in value in an investment. This rule states that for money compounded annually, the anal interest rate ‘multiplied by the number of years is approximately 72. It may be expressed in one of the following ways: , R Annual Inerest Rate x#ofyeas=72 OR of years~ gar peeeest Rate Investigate the nile by comparing the results of the Rule of 72 to the results with TVM Solver “Rule of 72" TVM Solver Interest Rate Time Tnterest Rate Time (Annual) (Years) (Annual) (Years) a) 9% a) 9% >) 2 >) R 9 4% ° 4% + Use the “Rule of 72” to estimate the umber of years it would take for an investment of $1000 to grow to $8000 ifthe annual interest rate was 7 2% + Check the accuracy of the answer using TVM Solver. Ne ‘Complete Assignment Questions #8 - #9Assignment 1. Caloulate the simple interest in each case: a) $785 is invested at 8% Db) $840 is invested at 6% per annum for one year. per year for six months. 2. $7 800 is invested in a 5 year GIC compounded yearly ata rate of 5% per annum. Determine the value of the investment at the end of the term. 3. Eight years ago, Julian invested $25 000 in technology stocks. The return on his investment was equivalent to arate of 7.75% per annum, compounded yearly. Determme the amount of interest he made on the investment. 4. Dorean has invested $1. ‘year investment compounded yeatly at a rate of 3.75% per annum. Determine the value of the investment at the end of the term, 5. Thice years ago, Candice invested $10 000 in high-risk stocks. The reum on her investment was equivalent to a rate of 17% per annum, compounded anaually. Determine the amount of interest she made on the investment. 6. Andre invested $7 000 in an investment paying 4.5% per annum compounded over eight ‘years. Would the interest eamed on the investment after four years be one-half of the interest eamed on the investment in eight years?7. A bond has been purchased for $1 500 and invested in an account bearing an annual interest rate of 6.25%. a) If the bond is a Regular Interest Bond then + complete the table below + write an equation that models this scenario + sketch a graph without numerical values that represents, ‘ts investment ‘Year ° 1 2 3 4 Value | s1s0000 | sis9a75 | si 68750 b) If the bond is a Compound Interest Bond then + complete the table below » write an equation that models this scenario * sketch a graph without numerical values that represents, this investment. ‘Year ° 1 2 Value | siso000 | sisoa7s | si 69336 8. Use the TVM Solver to verify the answers to questions #2 - #5 of this assignment, Place your values in the charts below. #4, Ne9. Complete the following charts by using the “Rule of 72” and then the TVM Solver feature of 2 graphing calculator. Use $5 000 as the initial investment. Round off to the nearest hundredth where necessary “Rule of 72” TVM Solver Interest Rate Time Interest Rate Time (Annual) (Years) (Annual) (Years) a) 10% a) 10% b) 14 b) 14 ° 1% ° 1% Answer Key 1. a) $62.80 b) $25.20 2. $9955.00 3. $20423.25 4) s2037968 5. $6016.13 6. No, because the interest is compounded, which means it follows an exponential patern. If the investment ‘paid regular interest (or simple interest), the interest earned would follow a linear pattern and then the statement would be true 7. a) + year 3, $1781.25 b) + year 3, $1799.19 ‘year 4, $1875.00 year 4, $1911.64 ear 5, $1968.75 year 5, $2031.12 93.75x + 1500 + y= 1500(1.0625F $e graph slow See graph below. 9. See tables below ‘Rale of 72" TVM Solver Taterest Rate [Time Tnterest Rate | Time (Annual) | (Wears) Annual) | (Years) 2 10% #2 2 30 FF » | see 14 » | Sosy 1 © 7% 20.29 © 1% 2024