GROUPE TANKOU ENSEIGNEMENT SUPERIEUR (GTES)

Department: AC1
Course Title: Financial Mathematics
Semester: First, Course Instructor: LUKONG Louis Y.
 1. THE BASICS AND DEFINITIONS
• Definition: Financial Mathematics is the application of mathematical methods to financial problems. It
draws on tools from probability, statistics, stochastic processes, and economic theories. Financial
mathematics is also referred to as quantitative finance, financial engineering, mathematical finance, and
computational finance. It is used to predict outcomes, identify trends, combine figures, and perform
various mathematical equations to complete financial tasks.
The basic premise of financial mathematics is that the price of an asset should reflect the risk and reward of
investing in it.
• Simple Interest: Simple interest is a method of calculating interest on a loan or investment that is based on
the original principal only. It is a quick and easy way to calculate the interest charge on a loan or the amount
yielded on an investment. Simple interest does not take into consideration any other charges associated with
the amount borrowed or deposited.

Definition of Some Important Terms

Let us define the following terms, which are important in the mathematics of finance.

Principal: The amount of money that is lent or borrowed initially is called principal. This will be denoted by P.

Interest: Interest is the amount charged in addition to the principal as the time value of money. We denote this by
I.

Time Period: The time period is the number of years or quarters or months or the fraction of these for which the
principal is lent or borrowed. Usually, the time period is denoted by n.

Amount: The amount is the total of the principal and the interest earned in a specified period of time. Alternatively,
it is known as accrued amount or future value. It is denoted by A.

Hence, Amount = Principal + Interest, i.e., A = P + I.

Rate of Interest: It is the sum of money payable to the lender for the use of unit principal for a unit period of time
i. If the principal is 100frs then the interest charged for one year is usually called the amount of interest per annum,
and is denoted by r ( = Pi). e.g., if the principal is 100frs and the interest 3, then we say
usually that the rate of interest is 3 percent per annum (or r = 3 %).

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Or simply, Amount A = P + I = P + P. i. n = P (1+ i.n) i.e. A = P (1 + n .i)
Observation. So here we find four unknown A, P, i., n, out of which if any three are known, the fourth one can
be calculated.

SOLVED EXAMPLES:

Example 1: Grace deposited 1200frs to a bank at 9% interest p.a. find the total interest that he will get at
the end of 3 years.

Here P = 1200, i = 9/100 = 0.09, = n = 3, I =?

I = P. i.n = 1200 x 0.09 x 3 = 324.

Grace will get 324frs as interest.

𝟏
Example 2: Amina borrowed $7500 at 14.5% p.a. for 𝟐 𝟐 years. Find the amount she had to pay after that

period.

𝟏𝟒.𝟒 𝟏
P = 7500, i = 𝟏𝟎𝟎
= 0.145, n = 𝟐 𝟐 = 2.5, A = ?

A = P (1+ in) = 7500 (1+ 0.145 x 2.5) = 7500 (1+0.3625)

= 7500 × 1.3625 = 10218.75

Reqd. amount = $10218.75.

More problems

1. Find the simple interest on 5600frs at 12% p.a. from July 15 to September 26, 2013.

2. What sum of money will amount to 1380frs in 3 years at 5% p.a. simple interest?

3. What principal will produce $50.50 interest in 2 years at 5% p.a. simple interest?

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 Commercial Present Value (CPV) and Rational Present Value (RPV)

Commercial Present Value (CPV):

Definition: CPV is a method used in financial mathematics to calculate the present value of a series of cash flows
assuming a fixed, commercial interest rate.

Formula:

𝐶𝐹1 𝐶𝐹2 𝐶𝐹𝑛

𝐶𝑃𝑉 = (1+𝑟)
+ (1+𝑟)2
+ ⋯+ (1+𝑟)𝑛

where 𝐶𝐹𝑖 is the cash flow in period i, r is the commercial interest rate, and n is the number of periods.

Rational Present Value (RPV):

Definition: RPV, on the other hand, considers a different interest rate for each cash flow, reflecting the actual cost
of capital for each period.

Formula:

𝐶𝐹1 𝐶𝐹2 𝐶𝐹𝑛

𝐶𝑃𝑉 = (1+𝑟1 )
+ (1+𝑟2 )2
+ ⋯+ (1+𝑟𝑛 )𝑛

where 𝑟𝑖 is the interest rate for period i.

Example:

Consider a project with cash flows of $1000 in the first year, $1500 in the second year, and $2000 in the third year.
The commercial interest rate is 5%, and the rational interest rates are 4%, 6%, and 8% for the first, second, and
third years, respectively.

Nominal and Effective Interest Rates

An interest rate takes two forms: nominal interest rate and effective interest rate. The nominal interest rate does
not take into account the compounding period. The effective interest rate does take the compounding period into
account and thus is a more accurate measure of interest charges.

A statement that the "interest rate is 10%" means that interest is 10% per year, compounded annually. In this case,
the nominal annual interest rate is 10%, and the effective annual interest rate is also 10%. However, if

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compounding is more frequent than once per year, then the effective interest rate will be greater than 10%. The
more often compounding occurs, the higher the effective interest rate.

The relationship between nominal annual and effective annual interest rates is:

ia = [ 1 + (r / m)]m - 1

where "ia" is the effective annual interest rate, "r" is the nominal annual interest rate, and "m" is the number of
compounding periods per year.

Example: A credit card company charges 21% interest per year, compounded monthly. What effective annual
interest rate does the company charge?

𝑟 = 0.21 𝑝𝑒𝑟 𝑦𝑒𝑎𝑟

𝑚 = 12 𝑚𝑜𝑛𝑡ℎ𝑠 𝑝𝑒𝑟 𝑦𝑒𝑎𝑟

𝑖𝑎 = [1 + (.21 / 12)] 12 − 1

= [1 + 0.0175] 12 − 1

= (1.0175)12 − 1 = 1.2314 − 1

= 0.2314 = 23.14%

It may be desired to find the effective interest rate for a period other than annual. In this case, adjust the period for
"r" and "m" as needed. For example, if the effective interest rate per semi-annual period (every 6 months) is desired,
then

r = nominal interest rate per 6 months

m = number of compounding periods per 6 months, and the effective interest rate, isa, per semi-annual period, is:

isa = [ 1 + (r / m)] m – 1

Forecasted Interest

Definition: Forecasted interest refers to the expected interest rate over a future period, often used in financial
planning and analysis.

Example: If the current interest rate is 5%, and financial analysts expect it to increase to 7% in the next year, the
forecasted interest rate for the next year is 7%.

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 2. SHORT-TERM FINANCIAL TRANSACTIONS (THE COMPOUND INTEREST)
2.1 Definition: A capital is said to be placed at compound interest when at the end of the first period,
the interest produced is added to the capital in other to produce its own interest for the next period and
in this light at the end of each of any other period.

The interest produced will depend on the duration or period which can be annual, semi -annual,
quarterly or even monthly. The number of periods will be denoted n.

The interest will also depend on the rate for 1 F I which is the rate per hundred divided by 100
That is to say i = r/100

Example: What will be the total amount in an account if 200 000F is placed for 3yrs at a compound
interest rate of 6%.

Period Capital at the start of the period Interest produced Capital obtained at the
during the year end of the year
1 200 000 200000*.06=12000 212000
2 212000 212000*.06=12720 224720
3 224720 224720*.06=13483.2 238203.2

2.2 Future Value in Compound Interest

Period Capital placed Interest for the period Capital at the end of the period
at the start
1 C Ci C+Ci=C(1+i)
2 C(1+i) C(1+i)i C(1+i)+C(1+i)i=C(1+i)2
2
3 C(1+i) C(1+i)2i C(1+i)2+C(1+i)2i=C(1+i)3
3
4 C(1+i) C(1+i)3i C(1+i)3+C(1+i)3i =C(1+i)4

n-1 C(1+i)n-2 C(1+i)n-2i C(1+i)n-2+C(1+i)n-2i = C(i+i)n-1

n C(1+i)n-1 C(1+i)n-1i C(1+i)n-1+C(1+i)n-1i=C(1+i)n

A = C(1+i)n
Example 1: TAMBI invested the sum of 500 000frs in a credit union account that yields interest at
the rate of 5% p.a. how much will he collect at the end of the 6th year.

Example 2: a capital of 100 000frs is invested at a compound interest rate of 6% p a for

a duration of 3 years, Calculate:
a— the Future value A

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b—the cumulative interest earned for the period. (hint: we subtract the principal from the future value)

NB: The acquired value of a certain amount invested at compound interest but on a duration which
is not an entire year that is to say a fraction of a year is involved can be calculated using three
methods.

The Use of the Rational Solution

The rational solution is used when the duration of an investment of a given sum is fractional. An
example of a fractional duration is; 2 years, 5 months.
The rational solution involves the use of the general formula for the Future value ( A ) and the use of
the simple interest formula for the fractional part. The formula is stated as follows;
A= C(1+i)n ( 1+ip/12)
Components of the formular--- C - capital
i - interest rate per 1 franc
n - Whole part of duration
p - fractional part of duration

Example3: Determine the future value of 100 000frs at the rate of 6% p a for a period of 6 years 5
months using the rational solution.

Using the Commercial Solution

This approach entails the use of the formular below;
A = C (1 + i)n ( 1 + i )p/12.

Example 4; using the commercial solution determine the future value of 100 000frs invested at the
rate of 6 % for the period of 6 years 5 months.
Likewise the future value can be calculated using the formular A= C(1+i)n+m/12 (hint: m/12 converts
5months to years and adds to n = 6 years)

Considering the previous exercise, the future value will be A= 100 000(1.06)6.4166666= 145338F

N.B: The Future values produced after any period follows a geometric progression with common
ratio (1+r)

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Application Exercise
Fuh Laura invested an amount X in BICEC at a compound interest rate of 5%. If her Future value
after 9 years is 1178973.85frs, Calculate the Future value after 12 years.

2.3 CALCULATION OF INTEREST

The interest I = Future value - capital I = C(1+i)n - C
I = C [ (1+i)n – 1 ]
Likewise, considering table 1 above it will be realized that the interest produced during the different
years form a series in geometric progression with common ratio r = (1+i) and first term a = Ci

Example: A capital of 500 000F is invested for 6yrs at a compound interest rate of 5%. Calculate the
total interest yielded during the first three years as well as the total interest yielded during the entire
six years.

2.4) CURRENT ACCOUNT IN COMPOUND INTEREST

A current account is one in which deposits and withdrawal can be done at any time. With compound
interest, the capital and interest will keep on yielding interest till the next deposit or withdrawal is
made.

Example 1: Mr. Ngong deposited 10,000,000 FRS into an account on the 1st January. Two years
after, he withdrew 2,500,000 FRS. Four years after the first deposit he withdrew the balance left. To
this balance he added 1,187.5 FRS and had 9400,000 FRS.
Work Required: Calculate the interest rate if the compounding is annual.

2.5) CALCULATION OF PROPORTIONAL AND EQUIVALENT RATE

Proportional Rate
The proportional rate is a way of expressing an annual interest rate in terms of smaller time periods,
such as semi-annual, quarterly, monthly, or daily rates. Let's denote the annual rate as r, and the rate
corresponding to a period k times smaller than the year as rk. The formula for the proportional rate is
given by rk=r/k.
Example 1: Convert a 10% annual rate to the proportional rate for different time periods:
a) Semi-annual rate: 10/2=5% b) Quarterly rate: 10/4=2.5%
c) Monthly rate: 10/12=0.83% d) Daily rate: 10/360=0.278%

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In this example, we are breaking down the annual rate of 10% into smaller time periods, and the
proportional rates for each period are calculated using the formula rk=r/k.

Example 2: convert 12% quarterly rate to the proportional rates for different time periods:
a) Annual rate
b) Semi annual rate
c) Daily rate
Solution

In this example, a quarterly rate of 12% is converted to equivalent rates for annual, semi-annual, and
daily periods using the proportional rate formula.
NB: It's important to note that these calculations are based on the assumption that interest is
compounded and applied at each smaller time period. The proportional rate allows for a standardized
comparison of interest rates across different compounding frequencies.
• Equivalent rate:
The equivalent rate is a concept used in compound interest calculations to express the interest rate
for a given period in terms of a different compounding frequency. Let's denote the annual rate as r
and the rate corresponding to a period k times smaller than the year as rk. The formula for the
equivalent rate is given by:

Example 1: calculate the semi-annual rate corresponding to an annual rate of 9.5%

Example 2: Convert an annual rate of 15% to the corresponding equivalent rates for different periods:
a) Quarterly rate
b) semi annual rate
c) daily rate

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Example 3: convert a quarterly rate of 5% to the equivalent rates for different periods:
a) annual rate
b) semi annual rate c) daily rate

These examples illustrate the use of the equivalent rate formula to find the corresponding interest
rates for different compounding frequencies, ensuring that the accumulated values over the specified
periods are equal.

3. CALCULATION OF THE AVERAGE RATE OF A SERIES OF SIMULTANEOUS

INVESTMENTS
The average rate of return for a series of simultaneous investments is a measure of the overall performance of
multiple investments made at the same time. It provides insight into the average profitability or return on
investment across the entire portfolio of investments.

Formula:

Total Net Gain or Loss: The sum of the individual net gains or losses for each investment. Net gain or loss is
calculated as the difference between the final value and the initial investment for each individual investment.

• For each investment, subtract the initial cost from the final value to determine the net gain or loss.
• Net Gain or Loss = Final Value - Initial Investment
• Total will be the sum of net gains or losses for all investments.

Total Initial Investment: The sum of the initial investments made in all the simultaneous investments.

Multiplying by 100: This is done to express the average rate of return as a percentage.

Interpretation:

• A positive average rate of return indicates that, on average, the investments have been profitable.
• A negative average rate of return suggests an overall loss on the investments.
• The percentage value provides a standardized measure, allowing for easier comparison with other
investment opportunities or benchmarks.

The average rate of return is a useful metric for assessing the overall success of a group of investments, providing
a more comprehensive view than looking at individual investment returns in isolation.

Example:
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Suppose you make three simultaneous investments:

1. Invest $10,000 and receive $12,000 after one year.

2. Invest $8,000 and receive $9,000 after one year.
3. Invest $15,000 and receive $16,000 after one year.

Calculations:

i. For the first investment: Net Gain = $12,000 - $10,000 = $2,000

ii. For the second investment: Net Gain = $9,000 - $8,000 = $1,000
iii. For the third investment: Net Gain = $16,000 - $15,000 = $1,000

Total Net Gain = $2,000 + $1,000 + $1,000 = $4,000

Total initial investment = $10,000 + $8,000 + $15,000 = $33,000

So, the average rate of return for these simultaneous investments is approximately 12.12%.

4. EQUIVALENCE AND REPLACEMENT EFFECT

In financial mathematics, equivalence refers to the concept of two or more payment streams being equal to each
other if they have the same economic value on the same focal date ¹. This concept is used to ensure that neither
party is penalized by any choice when making alternative financial arrangements.

Replacement of equivalent refers to the process of replacing one payment stream with another that has the same
economic value on the same focal date. This is done to ensure that the new deal is fair to all parties concerned.

Here are some examples of how to use these concepts:

Example 1:

Suppose you have a choice between receiving $1000 today or $1200 in 2 years. If the interest rate is 5%, which
option should you choose?

To solve this problem, we need to determine the present value of the future payment of $1200. Using the formula
for present value, we get:

𝑃𝑉 = 𝐹𝑉 / (1 + 𝑟)𝑛

where PV is the present value, FV is the future value, r is the interest rate, and n is the number of periods.

In this case, n = 2 and r = 5%. Therefore, the present value of $1200 is:

PV = 1200 / (1 + 0.05)2
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PV = 1067.14

Since $1000 is less than $1067.14, it is better to take the $1000 today.

Example 2:

Suppose you have a loan with a monthly payment of $500 for 5 years. If the interest rate is 6%, what is the present
value of the loan?

To solve this problem, we need to determine the present value of the payment stream of $500 per month for 5
years. Using the formula for present value of an annuity, we get:

𝑃𝑉 = 𝑃𝑀𝑇 ∗ ((1 − (1 + 𝑟)−𝑛 ) / 𝑟)

where PV is the present value, PMT is the payment amount, r is the interest rate per period, and n is the number
of periods.

In this case, PMT = $500, r = 6%/12 = 0.5%, and n = 5*12 = 60. Therefore, the present value of the loan is:

PV = 500 * ((1 - (1 + 0.005)-60) / 0.005)

PV = 26,764.88

Therefore, the present value of the loan is $26,764.88.

Current Account and interest (Reviewed)

In short-term financial transactions, a current account is a type of bank account that is used for short-term
transactions. It deals with a country’s short-term transactions or the difference between its savings and investments.
These are also referred to as actual transactions (as they have a real impact on income), output, and employment
levels through the movement of goods and services in the economy.

Interest is the cost of borrowing money, usually expressed as a percentage of the amount borrowed. In short-
term financial transactions, interest is often charged on loans or other forms of credit that are used to finance short-
term needs.

Here are some examples of how to use these concepts:

Example 1:

Suppose you have a current account with a balance of $1000 and an interest rate of 5%. If you withdraw $500
from the account after 6 months, what will be the new balance?

To solve this problem, we need to determine the interest earned on the account over the 6-month period. Using the
formula for simple interest, we get:

I=P*r*t
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where I is the interest earned, P is the principal amount, r is the interest rate, and t is the time period.

In this case, P = $1000, r = 5%/12 = 0.42%, and t = 6/12 = 0.5. Therefore, the interest earned is:

I = 1000 * 0.0042 * 0.5

I = 2.10

Therefore, the new balance in the account will be:

New balance = 1000 - 500 + 2.10

New balance = 502.10

Example 2:

Suppose you have a loan with a principal amount of $10,000 and an interest rate of 8% per annum. If the loan is
to be repaid in 6 months, what is the monthly payment?

To solve this problem, we need to determine the monthly payment required to repay the loan in 6 months. Using
the formula for present value of an annuity, we get:

PMT = PV * r / (1 - (1 + r)-n)

where PMT is the monthly payment, PV is the present value of the loan, r is the interest rate per period, and n is
the number of periods.

In this case, r = 8%/12 = 0.67%, and n = 6. Therefore, the present value of the loan is:

PV = 10000 / (1 + 0.0067)6

PV = 9,276.56

Therefore, the monthly payment required to repay the loan in 6 months is:

PMT = 9276.56 * 0.0067 / (1 - (1 + 0.0067)-6)

PMT = 1,609.14

5. ANNUITIES
Definition: Annuities is a series of payments or deposits realised in constant intervals of time with the intention
of repaying (settling) a loan or to constitute (raise) a capital. The time interval can be a year, semester, quarter,
or a month.
The payment of annuities can be done:

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• At the beginning of the period: This is the case of capitalisation annuities (constituting a capital). In
this case, the first payment or deposit can be done upon signature of the contract.
• At the end of the period: This is the case of reimbursement annuities (repaying back a loan). In this
case, the first payment comes at the end of the period.

Constant Annuities of Beginning of Period

Beginning of period annuities are constant deposits made in constant time intervals with the intention of
raising-up a capital. The characteristics of beginning of period constant annuities are the elements below.

a) Acquired Value (AV): The Acquired Value of a series of beginning of period annuities is the total sum
(𝟏+𝒊)𝒏 −𝟏
constituted by the annuities one year after the last deposit. 𝑨𝑽 = 𝒂(𝟏 + 𝒊)
𝒊

𝑊ℎ𝑒𝑟𝑒:
𝐴𝑉 = 𝐴𝑐𝑞𝑢𝑖𝑟𝑒𝑑 𝑉𝑎𝑙𝑢𝑒,
𝑎 = 𝐶𝑜𝑛𝑠𝑡𝑎𝑛𝑡 𝐴𝑛𝑛𝑢𝑖𝑡𝑦,
𝑟
𝑖= , 𝑤ℎ𝑒𝑟𝑒 ′𝑟 ′ 𝑖𝑠 𝑡ℎ𝑒 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑟𝑎𝑡𝑒,
100
𝑛 = 𝑡ℎ𝑒 𝑛𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑐𝑜𝑛𝑠𝑡𝑎𝑛𝑡 𝑑𝑒𝑝𝑜𝑠𝑖𝑡𝑠 (𝑎𝑛𝑛𝑢𝑖𝑡𝑖𝑒𝑠)
Example: John wants to constitute a capital of 17 000 000F through 20 constant annuities of beginning of
period at an interest rate of 10% per annum (p.a). Determine the amount of each constant deposit.
Solution: a = 269 808.29F

b) Original Value (OV): The Original Value or Present Value of a series of beginning of period annuities is
𝟏−(𝟏+𝒊)−𝒏
the value of the annuities at the time of the first deposit. 𝑶𝑽 = 𝒂(𝟏 + 𝒊)
𝒊

The diagram below shows the elements of constant annuities of beginning of period.

Example: Calculate the original value of a series of 8 constant annuities of beginning of period of 1 000 000F
each at an interest rate of 5% p.a.

Constant Annuities of End of Period

End of period annuities are constant payments made in constant time intervals by a borrower to a lender with the
aim of repaying back a loan. The characteristics of end of period constant annuities are the elements below.

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 a) Acquired Value (AV): The Acquired Value of a series of end of period annuities is the total sum
(𝟏+𝒊)𝒏 −𝟏
constituted by the annuities at the moment of the last deposit. 𝑨𝑽 = 𝒂 𝒊

𝑊ℎ𝑒𝑟𝑒:
𝐴𝑉 = 𝐴𝑐𝑞𝑢𝑖𝑟𝑒𝑑 𝑉𝑎𝑙𝑢𝑒,
𝑎 = 𝐶𝑜𝑛𝑠𝑡𝑎𝑛𝑡 𝐴𝑛𝑛𝑢𝑖𝑡𝑦,
𝑟
𝑖= , 𝑤ℎ𝑒𝑟𝑒 ′𝑟 ′ 𝑖𝑠 𝑡ℎ𝑒 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑟𝑎𝑡𝑒,
100
𝑛 = 𝑡ℎ𝑒 𝑛𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑐𝑜𝑛𝑠𝑡𝑎𝑛𝑡 𝑑𝑒𝑝𝑜𝑠𝑖𝑡𝑠 (𝑎𝑛𝑛𝑢𝑖𝑡𝑖𝑒𝑠)

Example: Calculate the Acquired Value of a series of 15 end of period constant annuities of 320 000F each
at an interest rate of 8% per annum.
Solution: Av = 8 688 676.457F

b) Original Value (OV): The Original Value or Present Value of a series of beginning of period annuities is
𝟏−(𝟏+𝒊)−𝒏
the value of the annuities at the time of the first deposit. 𝑶𝑽 = 𝒂 𝒊

The diagram below shows the elements of constant annuities of beginning of period.

Example: 10 constant annuities actualised at an annual interest rate of 10.5% obtained an Original Value of 2 000
000F. Calculate the constant annuity.

Solution: a = 332 514.64F

Evaluation of a Series of Annuities at a Given Date ‘p’.

• 𝑊ℎ𝑒𝑛 𝑝 > 0, 𝑉𝑃 = 𝑂𝑉(1 + 𝑖)𝑝

• 𝑊ℎ𝑒𝑛 𝑝 < 0, 𝑉𝑃 = 𝑂𝑉(1 + 𝑖)−𝑝

Example: A business man had to reimburse a loan by deposits of 5 constant annuities of 10 000F each, with the
first deposit falling due one year after the conclusion of the loan contract. However, he decided to pay back this
loan through a single deposit at the end of the seventh year.

Work Require: Calculate the amount of the single deposit at an interest rate of 6% p.a.

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NB:
• When the evaluation of a series of annuities is done one year before the first deposit or payment, it is
𝟏−(𝟏+𝒊)−𝒏
referred to as an immediate series of annuities. 𝑶𝑽 = 𝒂 𝒊

• When the evaluation of a series of annuities is done ‘p’ periods before the immediate date (one year before
𝟏−(𝟏+𝒊)−𝒏
1st deposit), the series is referred to as a deferred series of annuities. 𝑉−𝑃 = [𝒂 𝒊
] (1 + 𝑖)−𝑝

• When the evaluation of a series of annuities is done ‘p’ periods after the immediate date (one year before
𝟏−(𝟏+𝒊)−𝒏
1st deposit), the series is referred to as an anticipated series of annuities. 𝑉𝑃 = [𝒂 𝒊
] (1 + 𝑖)𝑝

Example: Consider a series of 8 constant annuities of end of period of 10 000F each at an interest rate of 6% p.a.
Calculate the value of these annuities:

1) One year before the first deposit.

2) 18 months before the first deposit.
3) 3 months before the first deposit.

Average Maturity of a Series of Annuities ‘x’

The average maturity (x) of a series of annuities is the period over which the value of the annuities is equal to the
total amount of annuities effectively paid. 𝐿𝑒𝑡 𝑡ℎ𝑒 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑀𝑎𝑡𝑢𝑟𝑖𝑡𝑦 𝑏𝑒 𝑥.
1 − (1 + 𝑖)−𝑛
⇒ [𝑎 ] (1 + 𝑖)𝑥 = 𝑛 × 𝑎,
𝑖
𝟏−(𝟏+𝒊)−𝒏
⇒[ 𝒊
] (1 + 𝑖)𝑥 = 𝑛
𝒏𝒊
𝒍𝒐𝒈
𝟏−(𝟏+𝒊)−𝒏
⇒𝒙= 𝒍𝒐𝒈(𝟏+𝒊)

Example: Calculate the average maturity of a series of 10 constant annuities of end of period at an interest rate of
6% p.a.

The Replacement of a Series of Annuities by Another.

For a series of annuity to be replaced by another, the two series of annuities must be equivalent.
Example: At the end of a borrowing contract, the borrower must pay 4 constant annuities of 50 000F each, with
the first falling due in 1 year. The borrower decided to discharge the loan by making 10 half yearly constant
payments, with the first falling due in 18 months.
Work Required: Calculate the constant amount of each half yearly payment at a half yearly rate of 4%.
Given Information:
• Original annuity: Four constant annuities of 50,000F each, with the first falling due in 1 year.
• New annuity: Ten half-yearly constant payments, with the first falling due in 18 months.
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• Half-yearly interest rate: 4%
Calculation: We'll use the formula for the present value of an annuity to find the constant amount of each
half-yearly payment.
The formula for the present value of an annuity is given by:

Where:
• PV is the present value of the annuity,
• PMT is the constant payment (annuity),
• r is the interest rate per period, and
• n is the total number of periods.
In this case:
• PMT is what we want to find (the constant half-yearly payment),
• r is the half-yearly interest rate (4% or 0.04 as a decimal),
• n is the total number of half-yearly periods.

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 JOINT BORROWING
Definition: A joint borrowing also called an ordinary loan is a loan accord by a unique lender usually a financial
institution to one or more borrowers. Joint borrowings are generally amortised (liquidated) or paid gradually or
cleared-off through constant annuities.

Elements of the Amortisation Table of Joint Borrowings.

a) The Loan Amount (OV): This is the value of the loan at the period ‘zero’ (start of the life of the loan).
b) The Amortisation (Ai): It represents the periodical value of the loan paid by the borrower. It can either
be constant or not constant during the life of the loan. The sum of all the amortisations is equal to the
amount of the loan.
c) The Interest (Ii): It represents the amount of loan yields to be paid by the borrower for the period ‘i’.
d) The Annuity (a): It represents the value of each periodical payment (constant or variable) of the borrower
to the lender in the process of liquidating the loan. This payment is made up of part of the loan and interest.
𝒂𝒊 = 𝑨𝒊 + 𝑰𝒊
e) The Duration (n): This is the life span of the loan, usually in years.
f) The Interest Rate (r): It represents the yield per hundred of the loan.
𝒓
g) The Interest Rate Coefficient (i): It is the interest rate divided by 100. 𝒊 = 𝟏𝟎𝟎

The Notion of Amortisation or Reimbursement of a Loan

The Liquidation of a loan (OV) can be done with the help of many methods.

a) Reimbursement by Constant Annuities: When the amortisation of a loan is done by constant annuities, the
following relationships are essential:

• The sum of the actualised values of the constant annuities is equal to the value of the loan. 𝑶𝑽 =
𝟏−(𝟏+𝒊)−𝒏 𝒊
𝒂 𝒊
, 𝑎𝑛𝑑 𝒂 = 𝑶𝑽 𝟏−(𝟏+𝒊)−𝒏

• The Amortisations are in a geometric progression with a common ratio of (1+i). 𝑶𝑽 =

(𝟏+𝒊)𝒏 −𝟏 𝒊
𝑨𝟏 𝒊
, 𝑎𝑛𝑑 𝑨𝟏 = 𝑶𝑽 (𝟏+𝒊)𝒏−𝟏

• 𝑶𝑽 =
𝒂−𝑨𝟏
𝒊

• 𝒂 = 𝑨𝒏(𝟏+𝒊)

Example: A loan of 5 000 000F is reimbursable by 5 constant annuities at an interest rate of 10% p.a. Present the
amortisation table.

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b) Reimbursement by Constant Amortisations: When the liquidation of a loan is done by constant
amortisations, the following relationships are essential:

• The amount of the loan divided by the life span of the loan is equal to each amortisation. 𝑨 =
𝑶𝑽
𝒏

• The annuities form a series of arithmetic progression with a common difference of 𝒅 = −

𝑶𝑽𝒊
𝒏

• 𝑶𝑽 =
𝒂−𝑨𝟏
𝒊

• 𝒂𝒏 = 𝑨𝒏(𝟏+𝒊)

Example: An investor borrowed a sum of 6 000 000F payable by constant amortisations at an interest rate of 5%
p.a. The amortisation of the first year amounted to 1 200 000F.
Work Required: 1) Calculate the duration of the loan,
2) Present the amortisation schedule.

c) Reimbursement by a Single Payment (Sinking Fund): When the liquidation of a loan is done by a Single
payment, the following relationships are paramount:

• The annuities of each year except the last year are equal to the respective interests of the years.
𝒂𝟏 = 𝒊𝟏 , ….

• The last amortisation liquidates all the loan. 𝑨𝒏 = 𝑶𝑽

• 𝑶𝑽 =
𝒂−𝑨𝟏
𝒊

• 𝒂𝒏 = 𝑨𝒏(𝟏+𝒊)

Example: A loan of 5 000 000F is contracted at an interest rate of 5% and amortisable by a Single payment after
4 years.
Work Required: Present the table of amortisation of this loan.

d) Reimbursement by Constant Annuities with Interest Paid in Advance: Here, the interest of the first year
is paid immediately upon the signature of the loan contract. Hence, the first interest is paid at the period ‘zero’.
Example: A loan of 500 000F is contracted at an interest rate of 10% and amortisable by constant annuities with
interest paid in advance for 4 years.
Work Required: Present the table of amortisation of this loan.

Calculation of the Loan Reimbursed after the Payment of the Pth Annuity.
(1+𝑖)𝑝 −1 (1+𝑖)𝑝 −1
Formulae: 𝑅𝑃 = 𝐴1 𝑖
, 𝑜𝑟 𝑅𝑃 = 𝑂𝑉 (1+𝑖)𝑛 −1

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Calculation of the Loan Remaining after the Payment of the Pth Annuity.
(1+𝑖)𝑛 −(1+𝑖)𝑝
Formulae: 𝐾𝑃 = 𝑂𝑉 − 𝑅𝑃 , ⇒ 𝐾𝑃 = 𝑂𝑉 (1+𝑖)𝑛 −1
, 𝑜𝑟

1 − (1 + 𝑖)−𝑛+𝑝
𝐾𝑃 = 𝑎
𝑖

Example: on the 01/01/2016, BICEC bank gave out a loan to her client reimbursable by constant annuities of 102
962.8F. The 1st annuity is payable on the 01/01/2017. The 1st amortisation amounted to 42 962.8F, and the 5th
amounted to 54 239.5468F.
Work Required:
1) Determine the interest rate of the loan.
2) Determine the amount of the loan.
3) Determine the life span of the loan.
4) Present the first four rows, and the last row of the loan amortisation table.
5) Calculate the amount of the loan reimbursed after the payment of the 10th annuity.
6) Calculate the amount of the loan remaining after the payment of the 7th annuity.

COMMERCIAL DISCOUNT
To be continued…

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