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GEN419-1 - 6. Interest

The document discusses different types of interest including simple, compound, and continuous interest. It provides formulas for calculating future values under each type of interest. Examples are worked through demonstrating how to calculate amounts owed or accumulated given the principal, interest rate, time period, and frequency of compounding. The document establishes important definitions for variables used in interest calculations like principal, future value, number of periods, interest rate, and number of compounding periods per year.

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Ahmed
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54 views20 pages

GEN419-1 - 6. Interest

The document discusses different types of interest including simple, compound, and continuous interest. It provides formulas for calculating future values under each type of interest. Examples are worked through demonstrating how to calculate amounts owed or accumulated given the principal, interest rate, time period, and frequency of compounding. The document establishes important definitions for variables used in interest calculations like principal, future value, number of periods, interest rate, and number of compounding periods per year.

Uploaded by

Ahmed
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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Cairo University

Faculty of Engineering
Chemical Engineering Department
Fourth Year

Economics

Interest

Eng. Nourhan Hisham


INTEREST
Interest
• Interest ≡ Time value of money.

• Interest is the fee charged by a lender to a borrower for

the use of borrowed money

• It is usually expressed as an annual percentage of

the principal.

• Interest per year divided by principal amount,


expressed as a percentage also called interest rate.
Important Definitions

• P Principal, the starting amount of money


• S Future value, sum, resultant, final money
• n Number of years (or period)
• i Interest rate (it may be annual , every 6 months ,every 3 months,
monthly)
• m Number of interest periods per year
• r Nominal interest rate
• i eff Effective interest rate
Interest Types
Simple vs. Compound vs. continuous

1- Simple interest:

Interest = P*n*i

S = P + P*n*i

S = P(1+i*n)
Interest Types
2- Discrete compounding interest:

𝑆 = 𝑃(1 + 𝑖)𝑛
i: annual interest rate
- Also if you have nominal interest rate use the law:
𝑟 𝑛.𝑚
𝑆 = 𝑃(1 + )
𝑚
𝑟
𝑆 = 𝑃(1 + )𝑛.𝑚 = 𝑃(1 + 𝑖𝑒𝑓𝑓 )𝑛
𝑚

𝑟
For n=1, (1 + )𝑚 = 1 + 𝑖𝑒𝑓𝑓
𝑚
𝑟 𝑚
𝑖𝑒𝑓𝑓 = (1 + ) −1
𝑚
Interest Types

3- Continuous compounded interest:

𝑆 = 𝑃𝑒 𝑟.𝑛
𝑖𝑒𝑓𝑓 = 𝑒 𝑟 − 1

Where:
r: Nominal annual interest rate
n: # of years
Interest Types
25000

20000

15000
Future Worth, $

S, Simple
S, Discrete
10000 S, Continuous

5000

0
0 2 4 6 8 10 12
Time, years
Interest Types

• Notes:
1- Simple interest is favorable when you borrow money.
2- The continuous compounded is favorable in case of putting
money in a bank.
3- Most of banks works by discrete interest type (As it has
intermediate value).
4- In most of our problems we use discrete.
5- If the interest type is not given, use simple interest.
LET’S BEGIN OUR SHEET
1) An individual borrows $1000 at 12% compounded
annually. If the loan is paid pack after 5 years, how
much is repaid?

P = $1,000
i = 0.12
Compound interest
n =5
S =?

𝑆 = 𝑃(1 + 𝑖)𝑛
𝑆 = 1000(1 + 0.12)5
𝑺 = $𝟏, 𝟕𝟔𝟐. 𝟑𝟒
2) Person A borrows $4,000 from person B and agrees to
pay $1000 plus accrued interest at the end of the first year
and $3,000 plus the accrued interest at the end of the
fourth year. What are the amounts of the two payments if
8% annual interest applies?

Year Zero Year One Year Four


P = $4,000 n=1 n=4
i = 0.08 S1= $1,000 + Interest 1 S1= $3,000 + Interest 2
Simple interest
S1 = ? Interest 1 = i * P * n Interest 1 = i * P * n
S2 = ? = 0.08 * 4000 * 1 = 0.08 * 3000 * 3
= $ 320 = $ 720

S1 = $ 1,320 S2 = $ 3,720
3) Person A wishes to accumulate $1,000 in a saving
account 4 years from now and the account pays
interest at a rate of 9% compounded annually. How
much must be deposited today?
S = $1,000
n =4
i = 0.09
Compound interest
P =?

𝑆 = 𝑃(1 + 𝑖)𝑛
1000 = 𝑃 ∗ (1 + 0.09)4
𝑷 = $𝟕𝟎𝟖. 𝟒𝟑
4) It is desired to have $9,000 available 12 years from
now. If $5,000 is available for investment at the present
time. What discrete annual rate of compound interest on
the investment would be necessary to give the desired
amount?
S = $9,000
n = 12
P = $5,000
i =?
Compound interest
𝑆 = 𝑃(1 + 𝑖)𝑛
9000 = 5000 ∗ (1 + 𝑖)12
𝒊 = 𝟎. 𝟎𝟓𝟎𝟐 = 𝟓. 𝟎𝟐%
5) What will be the total amount available 10 years from
now if $2,000 is deposited at the present time with
nominal interest at the rate of 6% compound semi-
annually?

P = $2,000
n = 10
r = 0.06 semi-annually, Compound interest
m = 2,
𝑟 𝑛.𝑚
𝑆 = 𝑃(1 + )
𝑚
0.06 10∗2
𝑆 = 2000 ∗ (1 + )
2
S = $𝟑, 𝟔𝟏𝟐. 𝟐
5) What will be the total amount available 10 years from
now if $2,000 is deposited at the present time with
nominal interest at the rate of 6% compound semi-
annually?
P = $2,000
n = 10
r = 0.06 semi-annually, Compound interest
m = 2,
Another solution:
2
𝑟 𝑚 0.06
𝑖𝑒𝑓𝑓 = (1 + ) −1 = 1 + − 1 = 0.0609
𝑚 2

𝑆 = 𝑃(1 + 𝑖𝑒𝑓𝑓 )𝑛 = 2000 ∗ 1 + 0.0609 10


= $𝟑, 𝟔𝟏𝟐. 𝟐
6) What will be the total amount available 10 years from
now if $2,000 is deposited at the present time with
nominal interest at the rate of 6% compound semi-
annually?
P = $2,000
n = 10
i = 0.06 semi-annually, Compound interest
m = 2,
r = 0.12
𝑟 𝑛.𝑚
𝑆 = 𝑃(1 + )
𝑚
0.12 10∗2
𝑆 = 2000 ∗ (1 + )
2
S = $𝟔, 𝟒𝟏𝟒. 𝟐𝟕
7) For the case of nominal annual interest rate of 20 %,
determine:
r = 0.2
(a) The total amount to which one dollar of initial principle
would accumulate after one year with continuous
compounding.
P = $1, n=1, S=?, continuous interest
𝑆 = 𝑃𝑒 𝑟.𝑛 = 1 ∗ 𝑒 0.2∗1 = $1.22
(b) The effective annual interest rate if compounding is
continuous.
𝑖𝑒𝑓𝑓 = 𝑒 𝑟 − 1 = 𝑒 0.2 − 1 = 0.22 =⇒ 22%

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