Module 7.

THE MATHEMATICS OF FINANCE

Good day, learner! I hope that you had understood the essence and
rules of statistics. The insights that you had learned from that
lesson is very vital to understanding and managing your data, the
results of your hard-worked research. This time, you are going to
learn the mathematics of finance. This is the second lesson for your
pre-finals. The knowledge of simple and compound interest is
essential for your future plans in investing.

Simple and Compound Interest

Definition of Terms
• Lender or creditor – person (or institution) who invests the money or makes the funds available
• Borrower or debtor – person (or institution) who owes the money or avails the funds from the lender
• Origin or loan date – date on which money is received by the borrower
• Repayment date or maturity date – date on which the money borrowed or loan is to be completely repaid
• Time or term (𝒕) – amount of time in years the money is borrowed or invested; length of time between the origin and
maturity date
• Principal (𝑷) – amount of money borrowed or invested on the origin date
• Interest (𝑰) – amount paid or earned for the use of money
• Simple Interest (𝑰𝒔) – interest that is computed on the principal and then added to it
• Compound interest (𝑰𝒄 ) – interest is computed on the principal and also on the accumulated past interests
• Maturity value or future value (𝒇) – amount after 𝒕 years, that the lender receives from the borrower on the maturity
date

Illustration of Simple and Compound Interest

Example 1. Suppose you won Php 10,000 and you plan to invest it for 5 years. A cooperative group offers 2% simple interest rate
per year, and a bank offers 2% compounded annually. Which will you choose and why?

Solution:
Investment 1: Simple interest, with annual interest rate 𝒓
Time Simple Interest: 𝑰 = 𝑷𝒓𝒕 Amount after t years (Maturity Value)
Principal (𝑷)
(t) Solution Answer 𝑭 = 𝑷(𝟏 + 𝒓𝒕)
1 (10,000)(0.02)(1) 200 10,200.00
2 (10,000)(0.02)(2) 400 10,400.00
3 10,000 (10,000)(0.02)(3) 600 10,600.00
4 (10,000)(0.02)(4) 800 10,800.00
5 (10,000)(0.02)(5) 1000 11,000.00

Investment 2: Compound Interest, with annual rate 𝒓

Amount at the start of Compound Interest Amount after t years
Time (t)
the year t Solution Answer (Maturity Value)
1 10,000 (10,000)(0.02)(1) 200 10,200.00
2 10,200 (10,200)(0.02)(1) 204 10,404.00
3 10,404 (10,404)(0.02)(1) 208.08 10,612.08
4 10,612.08 (10,612.08)(0.02)(1) 212.24 10,824.32
5 10,824.32 (10,824.32)(0.02)(1) 216.49 11,040.81

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Interest gained in the two investments Example 3.
Simple Interest (in pesos): 11,000 – 10,000 = Complete the table below by finding the unknown. Use
1,000 simple interest:
Compound Interest (in pesos): 11,040.81 – Principal (𝑷) Rate (r) Time (t) Interest
10,000 = 1,040.81
(a) 2.5% 4 1,500
Annual Simple Interest 36,000 (b) 1.5 4,860
𝑰𝒔 = 𝑷𝒓𝒕 250,000 0.5% (c) 275
Where: 500,000 12.5% 10 (d)
𝑰𝒔 = simple interest
𝑷 = principal
Solution:
𝒓 = rate
a. The unknown principal can be obtained by
𝒕 = time or term, in years 𝐼 1,500
𝑃 = 𝑟𝑡𝑠 = (0.025)(4) = 15,000
Example 1.
A bank offers 0.25% annual simple interest for a b. The unknown rate can be computed by
particular deposit. How much interest will be earned if 1 𝐼𝑠 4,860
𝑟= = = 0.09 = 9%
million pesos is deposited in this savings account for 1 𝑃𝑡 (36,000)(1.5)
year?
Solution: c. The unknown time can be calculated by
Given: 𝑃 = 1,000,000 𝐼 275
𝑡 = 𝑃𝑟𝑠 = (250,000)(0.005) = 0.22 year
𝑟 = 0.25% = 0.0025
𝑡 = 1 year d. The unknown simple interest can be calculated by
Find: 𝐼𝑠 𝐼𝑠 = 𝑃𝑟𝑡 = (500,000)(0.125)(10)
𝐼𝑠 = 𝑃𝑟𝑡 = 625,000
𝐼𝑠 = (1,000,000)(0.0025)(1)
𝐼𝑠 = 2,500 Example 4.
Answer: The interest earned is Php 2,500. When invested at an annual interest rate of 7%, an amount
earned Php 11,200 of simple interest in two years. How
Example 2. much money was originally invested?
How much interest is charged when Php 50,000 is
borrowed for 9 months at an annual simple interest rate of Given: 𝑟 = 7% = 0.07
10%? 𝑡 = 2 𝑦𝑒𝑎𝑟𝑠
𝐼𝑠 = 11,200
Solution: Find: 𝑃
Given: 𝑃 = 50,000 𝑃=
𝐼𝑠 11,200
= (0.07)(2) = 80,000
𝑟𝑡
𝑟 = 10% = 0.1
9
𝑡 = 12 year = 0.75 year
Answer: The amount invested is Php 80,000.
Find: 𝐼𝑠
Note: When the term is expressed in months (𝑀), it should Example 5.
𝑀
be converted to years by 𝑡 = An entrepreneur applies for a loan amounting to Php
12
𝐼𝑠 = 𝑃𝑟𝑡 500,000 in a bank. The simple interest of which is Php
𝐼𝑠 = (50,000)(0.1)(0.75) 157,500 for 3 years. What interest rate is being charged?
𝐼𝑠 = 3,750 Solution:
Answer: The interest earned is Php 3,750. Given: 𝑃 = 500,000
𝑡 = 3 𝑦𝑒𝑎𝑟𝑠
𝐼𝑠 = 157,000
Find: 𝑟
𝐼𝑠 157,000
𝑟= = = 0.105
𝑃𝑡 (500,000)(3)
= 10.5%

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Answer: The bank charged an annual simple interest rate Thus, the interest earned at a certain time intervals is
of 10.5%. automatically reinvested to yield more interest.

Example 6. The following table shows the amount at the end of each
How long will a principal earn an interest equal to half of it year if principal P is invested at an annual interest rate r
at 5% simple interest? compounded annually. Computations for the particular
Solution: example 𝑃 = 𝑃ℎ𝑝 100,000 and 𝑟 = 5% are also
Given: 𝑟 = 5% = 0.05 included
1
𝐼𝑠 = 𝑃 = 0.5𝑃
2
Principal = 𝑷
Find: 𝑡 Principal = 𝑷𝒉𝒑 𝟏𝟎𝟎, 𝟎𝟎𝟎
Interest rate =
𝐼𝑠 0.5𝑃 Interest rate = 5% compounded
𝑡= = = 10 𝑦𝑒𝑎𝑟𝑠 Year 𝒓, compounded
annually
annually
𝑃𝑟 (𝑃)(0.05) (t)
Answer: It will take 10 years for a principal to earn half of its Equation for
Amount at the end of the year
value at 5% simple annual interest rate. the amount
1 𝑃(1 + 𝑟) 100,000 ∙ 1.05 = 105,000
2 𝑃(1 + 𝑟)2 100,000 ∙ 1.1025 = 110,250
Many persons or institutions are interested to know the 3 𝑃(1 + 𝑟)3 100,000 ∙ 1.157625 = 115,762.5
amount the lender will give to the borrower on the maturity 4 𝑃(1 + 𝑟)4 100,000 ∙ 1.21550625 = 121,550.62
date. For instance, you may be interested to know the total
amount of money in a savings account after 𝒕 years at an Maturity (Future) Value and Compound Interest
interest rate 𝒓. This amount is called maturity value or the 𝑭 = 𝑷(𝟏 + 𝒓)𝒕
future value 𝑭. Where:
𝑃 = principal or present value
Maturity (Future) Value 𝐹 = maturity (future) value at the end of the term
𝑭 = 𝑷 + 𝑰𝒔 𝑟 = interest rate
= 𝑷 + 𝑷𝒓𝒕 𝑡 = term/ time in years
𝑭 = 𝑷 (𝟏 + 𝒓𝒕) The compound interest, 𝑰𝒄 = 𝑭 − 𝑷
Where: 𝐹 = maturity (future) value Example 1.
𝑃 = principal Find the maturity value and the compound interest if Php
𝐼𝑠 = simple interest 10,000 is compounded annually at an interest rate of 2% in
𝑟 = interest rate 5 years.
𝑡 = term/time in years Solution.
Example 7. Given: 𝑃 = 10,000
Find the maturity value if 1 million pesos is deposited in a 𝑟 = 2% = 0.02
bank at an annual simple interest of 0.25% after 𝑡 = 5 𝑦𝑒𝑎𝑟𝑠
a. 1 year? Find: a. maturity value 𝐹
b. 5 years? b. compound interest 𝐼𝑐
Solution: Solution:
Given: 𝑃 = 1,000,000, 𝑟 = 0.25% = 0.0025 a. 𝐹 = 𝑃(1 + 𝑟)𝑡
Find: a. Maturity or future value 𝐹 after 1 year 𝐹 = (10,000)(1 + 0.02)5
b. Maturity or future value 𝐹 after 5 years 𝐹 = 11,040.81
Note: There are two ways to solve the problem. b. 𝐼𝑐 = 𝐹 − 𝑃
Method 1. Solve the simple interest first then add it to P, 𝐼𝑐 = 11,040.81 − 10,000
that is 𝐹 = 𝑃 + 𝐼𝑠 . 𝐼𝑐 = 1,040.81
Method 2. Use the derived formula: 𝐹 = 𝑃 (1 + 𝑟𝑡) Answer: The future value F is Php 11,040.81 and the
compound interest is Php 1,040.81
Compound Interest
Many bank savings accounts pay compound interest. In this Example 2.
case, the interest is added to the account at regular intervals, Find the maturity value and interest if Php 50,000 is
and the sum becomes the new basis for computing interest. invested at 5% compounded annually for 8 years.
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Solution: The present value of 𝑃 can be obtained by
200,000
a. 𝐹 = 𝑃(1 + 𝑟)𝑡 𝑃 = (1+0.011)6
𝐹 = (50,000)(1 + 0.05)8 𝑃 = 187,293.65
𝐹 = 73,872.77 Answer: The present value is Php 187,293.65.
b. 𝐼𝑐 = 𝐹 − 𝑃
𝐼𝑐 = 73,872.77 − 50,000 Example 6.
What is the rate when Php 50,000.00 is used to gain an
𝐼𝑐 = 23,872.77
interest of Php 25,000 after 5 years?
Given: 𝑃 = 50,000
Example 3. Work on your own. 𝐼𝑐 = 25,000
Suppose Grandma deposited in a bank for Starla (NINNA 𝑡=5
ISABELLE) amounting to Php 100,000.00 at an annual Find: 𝑟
interest of 5% compounded yearly when she graduates from Solution:
Kindergarten and did not get the amount until she finished =𝐹−𝑃
Grade 12. How much will Starla has in her bank account 𝐼𝑐 = 𝑃(1 + 𝑟)𝑡 − 𝑃
𝐼𝑐 = 𝑃[(1 + 𝑟)𝑡 − 1]
after 12 years? 𝐼𝑐
= (1 + 𝑟 )𝑡 − 1
𝑃
𝐼𝑐
Present Value 𝑷 at Compound Interest + 1 = (1 + 𝑟 )𝑡
𝑃
𝑭 𝐼𝑐
𝑷= (1 + 𝑟 )𝑡 = +1
(𝟏 + 𝒓)𝒕 𝑃
1
Where 𝐼𝑐 𝑡
𝑃 = principal or present value 1 + 𝑟 = ( + 1)
𝑃
𝐹 = maturity (future) value at the end of the term 𝟏
𝑰𝒄 𝒕
𝑟 = interest rate 𝒓 = ( + 𝟏) − 𝟏
𝑡 = term/time in years 𝑷
1
25000 5
𝑟 = (50000 + 1) − 1
Example 4.
What is the present value of Php 50,000 due in 7 years if 𝑟 = 0.084471 … ∗ 100% = 8.45%
money is worth 10% compounded annually? 𝐹
Solution: 𝑃 = (1 + 𝑟)𝑡 𝐹 = 𝑃 (1 + 𝑟 )𝑡
Given: 𝐹 = 50,000 𝐹
𝑟 = 10% = 0.1 (1 + 𝑟 )𝑡 =
𝑃
𝑡 = 7 𝑦𝑒𝑎𝑟𝑠 𝐹
ln(1 + 𝑟)𝑡 = ln
𝑃
Find: 𝑃 𝐹
The present value of P can be obtained by 𝑡 ln(1 + 𝑟) = ln
𝑃
𝐹 𝑭
𝑃 = (1 + 𝑟)𝑡 𝐥𝐧 𝑷
50,000 𝒕=
𝑃 = (1 𝐥𝐧(𝟏 + 𝒓)
+ 0.1)7
𝑃 = 25,657.91
𝐹
Answer: The present value is Php 25,657.91. (1 + 𝑟)𝑡 =
𝑃
Example 5. 𝑡 𝐹
How much money should a student place in a time deposit 1 + 𝑟=√
𝑃
in a bank that pays 1.1% compounded annually so that he
will have Php 200,000 after 6 years? 𝒕 𝑭
𝒓 =√ −𝟏
𝑷
Solution:
Given: 𝐹 = 200,000 5 75000
= √50000 − 1
𝑟 = 1.1% = 0.011
𝑡 = 6 𝑦𝑒𝑎𝑟𝑠 𝑟 = 0.0844717712 = 8.45%
Find: 𝑃

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Example 7. 𝑰
𝐥𝐧( 𝒄+𝟏)
𝑷
What is the time when Php 50,000 gains Php 25,000 at a 𝒕= 𝐥𝐧 (𝟏+𝒓)
rate of 10%?
25000
ln( 50000 + 1)
Solution: 𝑡=
𝐼𝑐 = 𝑃[(1 + 𝑟)𝑡 − 1] ln(1 + 0.1)
𝐼𝑐
+ 1 = (1 + 𝑟 )𝑡 𝑡 = 4.2541 … 𝑦𝑒𝑎𝑟𝑠 = 4.25 𝑦𝑒𝑎𝑟𝑠
𝑃
𝐼𝑐
ln( + 1) = 𝑡 ln (1 + 𝑟)
𝑃

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