The Mathematics of Finance

“If are born poor it is not your mistake, but if you die poor it’s your mistakes”

– Bill Gates

Your future is dependent on what you are doing now and how you are preparing for it. A better
future is associated with money because we believe that money affects how we lead our lead. If you have
money you can do and have with many things you want in life. But, if you have money and do not know
how to manage it, you will end up to nothing.

You are responsible for your personal finance. The concepts you will learn in this lesson will be a
great help to your personal financial planning.

Interest (I)

Interest is the cost for the use of money. When you deposit money in a bank, it will earn interest
but when you borrow money from a bank, you will pay interest.

Principal (𝑃) –is the amount deposited in a bank or borrowed from a bank

Interest Rate (𝑟) – percent use to determine the amount of interest

Time (𝑡) – the duration of deposit or loan

Simple Interest – the interest paid on the original principal

Simple Interest Formula

𝐼 𝐼 𝐼
𝐼 = 𝑃𝑟𝑡; 𝑃= ; 𝑟= ; 𝑡=
𝑟𝑡 𝑃𝑡 𝑃𝑟
Example 1. You have deposited ₱ 5,000 in a Savings Bank on January 1, 2016 with an interest rate of 3%
and have withdrawn it on January 1, 2017. Calculate the simple interest.

Solution: Calculate the interest

𝐼 = 𝑃𝑟𝑡
𝐼 = (₱ 5,000)(0.03)(1)
𝐼 = ₱ 150
Example 2. Your savings deposit of ₱ 7,000 earns a simple interest of 5%. How much is the interest for 9
months?

Given:

𝑃 = ₱7,000
𝑟 = 5%
9
𝑡 = 12
since the rate is annual
Calculation:

𝐼 = 𝑃𝑟𝑡
9
𝐼 = (₱ 7,000)(0.05) ( )
12
𝐼 = ₱ 262.50
In exact method,
𝑛𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑑𝑎𝑦𝑠
𝑡=
365
While in ordinary method,
𝑛𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑑𝑎𝑦𝑠
𝑡=
360
In most businesses, ordinary method is used unless otherwise stated.

Example 3. Calculate the simple interest due on a 72-day loan of ₱ 3,000 if the annual interest rate is
4%. Solution we will substitute the following values in the simple interest formula:
72
𝑃 = ₱ 3,000, 𝑟 = 4%, and 𝑡 = 360

Hence, the interest is:

𝐼 = 𝑃𝑟𝑡
72
𝐼 = (₱ 3,000)(0.04) ( )
360
𝐼 = ₱ 24
Maturity or Future Value (A)

The maturity or future value is the sum of the principal and the interest. The formula is 𝐴 = 𝑃 +
𝐼. If we substitute 𝑃𝑟𝑡 to 𝐼, we will have 𝐴 = 𝑃 + 𝑃𝑟𝑡 or 𝐴 = 𝑃(1 + 𝑟𝑡).

Example. A cooperative released a ₱ 9,000 – emergency loan to Ana with a simple interest of 4.5
%. If she intends to pay it in 2 years, what amount will she pay back to the cooperative?

Solution: To compute for the amount she will pay back after 2 years.

𝐴 = 𝑃 + 𝑃𝑟𝑡
𝐴 = ₱ 9,000 + (₱ 9,000)(0.045)(2)

𝐴 = ₱ 9,000 + ₱ 810
𝐴 = ₱ 9,810
Present Value (S)

The interest on loans may be deducted in advance from the principal amount, so if a borrower
applies for a loan of ₱ 10,000, he will receive an amount of less than ₱ 10,000 since the interest is deducted
from the principal loan before it is released to him, the borrower.

𝑆 = 𝑃– 𝐼
𝑆 = 𝑃– 𝑃𝑟𝑡
𝑆 = 𝑃(1– 𝑟𝑡)
Example. Kleah needs ₱ 25,000 now to buy a laptop. She has decided to borrow money from a
lending company that charges 8% simple interest deducted in advance. How much loan
will Kleah apply for if she pays it in 2 years?

Given: 𝑆 = ₱ 25,000

𝑟 = .08
𝑡 = 2 𝑦𝑒𝑎𝑟𝑠
Solution:

₱ 25,000 = 𝑃 (1– (.08)(2))

₱ 25,000 = 𝑃(1– 0.16)
₱ 25,000 = 𝑃(0.84)
₱ 25,000 𝑃(0.84)
0.84
= 0.84

𝑃 = ₱ 29,761.9
Kleah should apply for a loan of ₱ 29,761.90 for her to receive ₱ 25,000 which she needs now to buy a
laptop.

Compound Interest
Compound Interest is a method of calculating interest periodically on the sum of the principal and
the accumulated interest of previous periods. It means that the earned interest will also earn interest.
Illustration:
Suppose you deposit ₱ 5,000 in a savings account earning 3% interest, compounded annually.
During the first year, the interest is computed as follows:
𝐼 = 𝑃𝑟𝑡
𝐼 = (₱ 5,000)(0.03)(1)

𝐼 = ₱ 150
After a year, the total amount in your account is:
 𝐴=𝑃+𝐼
𝐴 = ₱ 5,000 + ₱ 150
𝐴 = ₱ 5.150
During the second year, the interest is computed using the total amount in your account after a
year.
𝐼 = 𝑃𝑟𝑡
𝐼 = (₱ 5,150)(0.03)(1)
𝐼 = ₱ 154.50
The amounts of interest earned on the first year and on the second year are different. It is bigger
on the second year because the interest was computed based on the sum of the principal and the interest
earned during the first year.
At the end of the second year, the total amount in your account is:
𝐴=𝑃+𝐼
𝐴 = ₱ 5,150 + ₱ 154.50
𝐴 = ₱ 5,304.50
To calculate the interest during the third year, we will use the total amount in your account at
the end of the second year
𝐼 = 𝑃𝑟𝑡
𝐼 = (₱ 5,304.50)(0.03)(1)

𝐼 = ₱ 159.14
You notice that the interest is increasing each year because the amount in your account is also
increasing every year.
The compounding period (n) of interest may not always be annually. It may be any of the following below:
If Interest is compounded N The number computation in a
year
Annually n=1 once
Semiannually n=2 twice
Quarterly n=4 4 times
Bimonthly n=6 6 times
Monthly n = 12 12 times
Daily n = 360 360 times

Example.
If ₱ 5,000 at 3% interest is compounded quarterly, there will be 4 compounding period in a year.
The interest during the first quarter is:
 𝐼 = 𝑃𝑟𝑡
3 3
𝐼 = (₱ 5,000)(0.03) (12) Note: 𝑡 =
12
since there are 3 months in one quarter

𝐼 = ₱ 37.50
The total amount in your account at the end of the first quarter is,
𝐴=𝑃+𝐼
𝐴 = ₱ 5,000 + ₱ 37.50
𝐴 = ₱ 5,037.50
During the second quarter, the interest is:
𝐼 = 𝑃𝑟𝑡
3
𝐼 = (₱ 5,037.50)(0.03) ( )
12
𝐼 = ₱ 37.78
The total amount in your account at the end of the second quarter is
𝐴=𝑃+𝐼
𝐴 = ₱ 5,037.50 + ₱ 37.78
𝐴 = ₱ 5,075.28
During the third quarter, the interest is:
𝐼 = 𝑃𝑟𝑡
3
𝐼 = (₱ 5,075.28)(0.03) ( )
12
𝐼 = ₱ 38.06
The total amount in your account at the end of the third quarter is:
𝐴=𝑃+𝐼
𝐴 = ₱ 5,075.28 + ₱ 38.06
𝐴 = ₱ 5,113.34
During the fourth quarter, the interest is:
𝐼 = 𝑃𝑟𝑡
3
𝐼 = (₱ 5,113.34)(0.03) ( )
12
𝐼 = ₱ 38.35
The total amount in your account at the end of the fourth quarter is:
 𝐴=𝑃+𝐼
𝐴 = ₱ 5,113.34 + ₱ 38.35
𝐴 = ₱ 5,151.69
The ₱ 5,000 at 3% compounded quarterly earns P 151.69 interest after 1 year, while the same
amount of the same interest but compounded annually earns an interest of ₱ 150 after 1 year. This implies
that more compounding periods in a year will yield greater interest.
The Compound Amount or Future-Value and Compound-Interest Formulas:
The compound amount can be calculated using the compound amount or future value formula.
𝑟 𝑛𝑡
𝐴 = 𝑃 (1 + )
𝑛
And for the compound interest, 𝐼 = 𝐴 − 𝑃
where: 𝐴 is the future value or compound amount
𝑃 is the original principal
𝑟 is the rate of interest
𝑡 is the time(duration of the loan/investment) in years
𝑛 is the number conversion periods per year
𝐼 is the compound interest
Example:
What is the compound amount and interest if ₱ 6,000 is invested at 2% compounded monthly for 2 years?
Solution: To calculate the compound amount, we will substitute the following values in the formula:
Given: 𝑃 = ₱ 6,000, 𝑟 = 2%, 𝑛 = 12, and 𝑡 = 2
𝑟 𝑛𝑡
𝐴 = 𝑃 (1 + 𝑛)

0.02 (12)(2)
𝐴 = ₱ 6,000 (1 + 12
)

𝐴 = ₱ 6,000(1 + 0.001667)24
𝐴 = ₱ 6,000(1.001667)24
𝐴 = ₱ 6,000(1.04078)
𝐴 = ₱ 6,244.68
The interest earned after 2 years is:
𝐼 =𝐴−𝑃
𝐼 = ₱ 6,244.68 − ₱ 6,000.00
𝐼 = ₱ 244.68
The Present Value Formula
The Present Value is the original principal invested before it earns interest, in compound-amount
formula, it is the (𝑃). Present value is the amount invested today and will have a specific value in the
future.
𝐴
𝑃= 𝑟 𝑛𝑡
(1+ )
𝑛

Where: 𝑃 is the original principal invested

𝐴 is the compound amount
𝑟 is the rate
𝑛 is the number of compounding periods per year
𝑡 is the time or the duration of the investment
Example: How much money should you invest at an interest rate of % compounded monthly, to
have ₱ 400,000 in 5 years?
Solution: Use the present value formula where 𝐴 = ₱ 400,000, 𝑟 = 6%, 𝑛 = 12 and 𝑡 = 5
𝐴
𝑃= 𝑟 𝑛𝑡
(1+ )
𝑛

₱ 400,000
𝑃= 0.06 12(5)
(1+ )
12

₱ 400,000
𝑃= (1.005)60

₱ 400,000
𝑃= 1.34885

𝑷 = ₱ 𝟐𝟗𝟔, 𝟓𝟒𝟖. 𝟗𝟏
You need to invest ₱ 296,548.91 to have ₱ 400,000 in 5 years.
Inflation
Inflation is an economic condition where there is an increase in the cost of goods and services. It
is expressed as a percent.
Example: Suppose your salary now is ₱ 28,000 per month. Assuming an annual inflation rate of 6%, what
will be the equivalent salary 10 years from now?
Solution: To calculate an equivalent salary in 10 years, the compound amount formula will be used.
Substitute the following values: 𝑃 = ₱ 28,000, 𝑟 = 0.06, 𝑛 = 1 (annual inflation) and 𝑡 = 10
𝑟 𝑛𝑡
𝐴 = 𝑃 (1 + )
𝑛
0.06 1(10)
𝐴 = 28,000 (1 + 1
)
 𝐴 = 28,000(1 + 0.06)10
𝐴 = 28,000(1 + 0.06)10
𝐴 = 28,000(1.06)
𝐴 = 28,000(1.7908)
𝑨 = 𝟓𝟎, 𝟏𝟒𝟐. 𝟒𝟎
In 10 years, you should earn a monthly salary of ₱ 50,142.40 to have the same purchasing power. This
further means that if you can buy a certain brand of refrigerator now, you can still buy the same brand 10
years from now if you earn that amount.
Effective Interest Rate
The compounded annual interest rate is called nominal rate while the simple interest rate that
would yield the same amount of interest after 1 year is effective rate. If the bank offers a savings account
that pays 3% compounded monthly and yielding 3.04%, the nominal interest rate is 3% and the effective
rate is 3.04%.
Example: A bank offers 4% compounded quarterly. What is the effective rate?
Solution: We will calculate the compound amount of a certain principal in 1 year with an interest
rate of 4% compounded quarterly. Assume 𝑃 = ₱ 100, 𝑟 = 0.04, 𝑛 = 4 and 𝑡 = 1
𝑟 𝑛𝑡
𝐴 = 𝑃 (1 + )
𝑛
0.04 4(1)
𝐴 = 100 (1 + 4
)

𝐴 = 100(1 + 0.04)4
𝐴 = 100(1.0406)
𝐴 = 104.06
To calculate for the effective rate, substitute 𝐼 = 4.06, 𝑃 = ₱ 100, and 𝑡 = 1 in the simple interest
formula.

𝐼 = 𝑃𝑟𝑡
4.06 = 100(𝑟)(1)
4.06 (100)(𝑟)
100
= 100

𝑟 = 0.0406
𝑟 = 4.06%
The interest rate of 4% compounded monthly will yield equal an amount of interest for a simple interest
rate of 4.06%.
Credit Cards and Consumer Loans
 An individual who uses a credit card in purchases is actually contracting a loan with the issuing
bank. It has zero interest for your purchases if you pay in full on or before the due date; otherwise, you
will pay an additional finance charge. Also a late payment fee is charged to your account if you fail to pay
at least the minimum amount required on or before the payment due date.
The most common method of determining finance charges is the average daily balance method.
Average daily balance is calculated by dividing the sum of the total amounts owed each day of the month
by the number of days in the billing period.
𝑠𝑢𝑚 𝑜𝑓 𝑡ℎ𝑒 𝑡𝑜𝑡𝑎𝑙 𝑎𝑚𝑜𝑢𝑛𝑡𝑠 𝑜𝑤𝑒𝑑 𝑒𝑎𝑐ℎ 𝑑𝑎𝑦 𝑜𝑓 𝑡ℎ𝑒 𝑚𝑜𝑛𝑡ℎ
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑑𝑎𝑖𝑙𝑦 𝑏𝑎𝑙𝑎𝑛𝑐𝑒 =
𝑛𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑑𝑎𝑦𝑠 𝑖𝑛 𝑡ℎ𝑒 𝑏𝑖𝑙𝑙𝑖𝑛𝑔 𝑝𝑒𝑟𝑖𝑜𝑑
Annual Percentage Rate (APR)
The annual percentage rate (APR) is the rate paid on a loan when the rate is based on the actual
amount owed for the length of time that is owed. Suppose you had a loan of ₱ 20,000 from a bank with a
simple interest of 8% payable in 2 years. In computing for the simple interest, the amount of interest for
2 years is,
𝐼 = 𝑃𝑟𝑡
𝐼 = (20,000)(0.08)(2)
𝐼 = 3,200
2𝑁𝑟
𝐴𝑃𝑅 = , 𝑁 = no. of payments, 𝑟 = interest rate
𝑁+1
2(2)(0.08)
𝐴𝑃𝑅 = 2+1

𝐴𝑃𝑅 = 0.1067
𝐴𝑃𝑅 = 10.67%
The annual percentage rate is 10.67%.
CONSUMER LOANS
Monthly Payment
The interest rate for consumer loans, such as car loan is normally the annual percentage rate (APR)
because it is required by the Truth in Lending Act. The amount of payment for a loan based on APR is
calculated using the formula,
𝑖
𝑃𝑀𝑇 = 𝐴 ( )
1 − (1 + 𝑖)−𝑛
where 𝑃𝑀𝑇 is the payment, 𝐴 is the loan amount, 𝑖 is the interest rate per payment period, and 𝑛 is the
total number of payments. If the annual interest rate is 7% and the payments for a loan are made monthly,
then
𝑎𝑛𝑛𝑢𝑎𝑙 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑟𝑎𝑡𝑒 0.07
𝑖 = 𝑛𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑝𝑎𝑦𝑚𝑒𝑛𝑡𝑠 𝑝𝑒𝑟 𝑦𝑒𝑎𝑟 = 12
= 0.0058

Example: A five-year loan is repaid on a monthly basis. What is the value of n in the formula for payment?
Answer: 𝑛 = 60
Example : Hannah purchases a cellular phone for ₱ 65,000. She makes a down payment of 10% and agrees
to repay the balance in 12 equal payments. If the balance is charged with a simple interest of 2%. Calculate
the monthly payment.
Solution: To calculate for the monthly payment, we substitute the values in the formula: down payment
0.02
is 10% of 65,000 or 6,500, 𝐴 = 65,000– 6,500 = 58,500, 𝑖 = 12 = 0.00167 monthly, and 𝑛 = 12
0.00167
𝑃𝑀𝑇 = 58,500 ( )
1−(1+0.00167)−12

𝑃𝑀𝑇 = 4,928.08
The monthly payment is ₱ 4,928.08
Note (scientific calculator)
58,500 × (0.00167 + 1 − (1 + 0.00167) 𝑦 𝑥 (−12))
Loan Payoffs
Loan payoff is paying the remaining loan before the end of the loan term. For example you had a
car loan payable in 5 years. After 3 years of payment you wanted to pay off the car loan. The payoff
amount is not just multiplying the monthly payment by the remaining 24 months because the
computation is based on APR. Below is the formula for APR Loan Payoff.
1 − (1 + 𝑖)−𝑛
𝐴 = 𝑃𝑀𝑇 ( )
𝑖
Where 𝐴 is the loan payoff, 𝑃𝑀𝑇 is the payment, 𝑖 is the interest per payment period, and 𝑛 is the number
of remaining payments.
Stocks
Companies may raise money either by borrowing or by selling their shares of stocks to finance the needs
of their operations and probably plan an expansion of their company.
Example: A stock pays an annual dividend of P60 per share. Calculate the dividend paid to Eva who has
120 shares of the company’s stock.
Solution: (120 𝑠ℎ𝑎𝑟𝑒𝑠) (60 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒) = ₱ 7,200
Eva received ₱ 7,200 in dividends.
Dividend Yield
Dividend yield is the amount of dividend divided by the price of the stock, and it is expressed as percent,
the same way as calling it the rate of the dividend in reference to the stock price.
Example : A stock pays an annual dividend of ₱ 80 per share. If the stock is trading at ₱ 1,500, what
is the dividend yield?
𝐼 = 𝑃𝑟𝑡
80 = (1,500)(𝑟)(1)
𝑟 = 0.053 𝑜𝑟 5.3%
The dividend yield is 5.3%
Market Value
The market value of a share of stock is the price for which the stock holder is willing to sell a share
of stock, and a buyer is willing to purchase it. Stock trades may have broken who also charge commissions
at varying levels. These things happen in the stock market. In the case of the Philippines, it is the Philippine
Stock Exchange (PSE)
Example: You owned 50 shares of stocks in Company A. You purchased the shares at a price of ₱
1,200 per share and sold them at ₱ 1,400 per share. If your broker charges 3.5% of the
total sale price, what is your profit or loss on the sale of stock? What is the commission
of the broker?
Solution: 𝑃𝑟𝑜𝑓𝑖𝑡 = 𝑆𝑒𝑙𝑙𝑖𝑛𝑔 𝑝𝑟𝑖𝑐𝑒 − 𝑃𝑢𝑟𝑐ℎ𝑎𝑠𝑒 𝑝𝑟𝑖𝑐𝑒
𝑃𝑟𝑜𝑓𝑖𝑡 = (1,400 × 50)– (1,200 × 50)
𝑃𝑟𝑜𝑓𝑖𝑡 = 10,000
The profit on the sale of the stock is ₱ 10,000
𝐶𝑜𝑚𝑚𝑖𝑠𝑠𝑖𝑜𝑛 = 0.035 × 70,000
𝐶𝑜𝑚𝑚𝑖𝑠𝑠𝑖𝑜𝑛 = 2,400
The broker’s commission was ₱ 2,400.
Bonds
Instead of selling stocks, the company may also issue a bond. When a bond is issued, the company
is borrowing money from the bondholder and promises to pay its face value at a maturity date along with
the given rate of interest called the coupon.
Example: A bond with a face value of ₱ 1,000 has a 4% coupon and a 15-year maturity date.
Solution: The interest is calculated using the simple interest formula, where 𝑃 = ₱ 1,000, 𝑟 = 0.04, and
𝑡 = 15
𝐼 = 𝑃𝑟𝑡
𝐼 = (1,000)(0.04)(15)
𝐼 = 600
The bond holder will receive the face value of ₱ 1,000 plus ₱ 600 for the interest.
Mutual Fund
A mutual fund, company is a business whose assets are stocks and bonds. Mutual fund units or
shares can be purchased or redeemed as needed at the funds current net asset value (NAV). The NAV is
dependent on the performance of the stocks in the fund and it can be calculated using the formula below
Net Asset Value of a Mutual Fund
𝐴−𝐿
𝑁𝐴𝑉 = 𝑁

where 𝐴 is the total fund assets, 𝐿 is the total liabilities, and 𝑁 is the number of shares.
House Ownership
When you do not have enough cash to purchase a home, you can apply for a housing loan in any financial
institution.
Mortgage is the amount that is borrowed to buy the property. The formula to find the mortgage is
𝑀𝑜𝑟𝑡𝑔𝑎𝑔𝑒 = 𝑆𝑒𝑙𝑙𝑖𝑛𝑔 𝑃𝑟𝑖𝑐𝑒 − 𝐸𝑞𝑢𝑖𝑡𝑦 𝑜𝑟 𝑀𝑜𝑟𝑡𝑔𝑎𝑔𝑒 = 𝑆𝑒𝑙𝑙𝑖𝑛𝑔 𝑃𝑟𝑖𝑐𝑒 − 𝐷𝑜𝑤𝑛 𝑃𝑎𝑦𝑚𝑒𝑛𝑡
Example: Suppose you buy a ₱ 1,700,000 house with an equity of ₱ 500,000. Find the mortgage
Solution: 𝑀𝑜𝑟𝑡𝑔𝑎𝑔𝑒 = 𝑆𝑒𝑙𝑙𝑖𝑛𝑔 𝑃𝑟𝑖𝑐𝑒 − 𝐸𝑞𝑢𝑖𝑡𝑦
𝑀𝑜𝑟𝑡𝑔𝑎𝑔𝑒 = 1,700,00 − 500,000
𝑀𝑜𝑟𝑡𝑔𝑎𝑔𝑒 = 1,200,000
Quiz # 5 – Math of finance
1. Suppose you buy a ₱ 2,500,000 house and lot with an equity of ₱ 700,000. Find the mortgage.

2. You plan to buy a house-and-lot through home loan from a bank. The selling price is ₱ 1,800,000
and the bank requires a down payment of 20% of the selling price. How much is the down
payment?

3. Suppose Anna purchases a condominium and secures a loan of ₱ 2,400,000 for 20 years at an
annual interest rate of 6.5%. Find the monthly mortgage payments.

4. You purchase a house-and-lot for ₱ 1,850,000 and obtain a 25-year fixed rate mortgage rate
mortgage of 8.5%. If the equity is ₱ 300,000, what is the monthly payment?