Financial Mathematics (Investment Mathematics)
Definition of Terms
Lender or Creditor – one who invests the money
Borrower or Debtor – one who owes money
Interest – a charge for borrowed money generally a percentage of the amount borrowed.
Simple Interest – is an interest computed on the amount the borrower received at the time the loan
is obtained and is added to that amount when the loan becomes due.
Bank Discount – the interest deducted in advance
Proceeds – the amount the borrower is to receive
Compound Interest – the interest is computed more than once during the time period of the loan.
Principal – is the amount of deposit made by a depositor or the face amount lent to the borrower on
loan date.
Rate – expressed as percentage, converted to a decimal for computation process.
Time – is the length of time for which the money is borrowed or lent. Also, expressed in years or
fractional part of a year, is the period between the loan and maturity date.
Loan Date – the date when the loan was obtained.
Maturity Date – the date when the loan becomes due.
Maturity Value – is the amount applied for by the borrower on loan date.
Banker’s Rule – (Ordinary Interest Using Actual Time) this time combination is being adopted by
banks since it yielded the highest interest out of the four-time combinations.
Promissory Note – (AKA Negotiable Instruments Law) is a written agreement between a lender and
a borrower that outlines the details of a loan, including the loan amount, interest rate, and repayment
terms.
Simple Interest and Bank Discount
Lender or Creditor – one who invest the money
Borrower or Debtor – one who owes
Simple Interest (I = PRT)
- An interest computed on the aount the borrower received at the time the loan is obtained and
is added to that amount when the loan becomes due. Thus, simple interest is computed only
once for the entire time period of the loan. (The computation of simple interest considers
three factors: principal, rate, and time)
- The time T in the simple interest formula I = PRT is the period between the loan date and the
maturity date.
Bank Discount - When interest is deducted in advance is called bank discount.
Problem Solving:
Luz Clarita borrowed P280,000 at a simple interest rate of 9% for one year. Compute for the simple
interest and maturity value of the loan.
Finding the Simple Interest
(Simple Interest is the product of the principal, rate, and time; or stated as formula.)
Formula:
Interest = Principal x Rate x Time
I = PRT
I = (280,000) (0.09) (1)
Interest = P25,200
(Thus, a loan of P280,000 for one year at simple interest rate of 9% will cost Luz Clarita P25,200 in
interest.)
Finding the Maturity Value
Problem Solving:
After one year, Luz Clarita’s loan matures and she is obliged to pay the maturity value of the loan.
This is the sum of the principal she received on loan date and the interest.
Formula:
Maturity Value = Principal + Interest
MV = P + I
MV = 280,000 + 25,200
MV = 305,200
Hence, on maturity date, in addition to the principal of P280,000 that Luz Clarita received when she
obtained the loan, she is to pay P25,200 in interest; or a total of P305,200.
Principal (P)– is the amount of deposit made by a depositor or the face amount lent to the borrower
on loan date.
Simple Interest Rate (R) – expressed as a percentage, is converted to a decimal for computation
purposes. Unless otherwise stated, the simple interest rate is an annual rate.
Time (T) – is the length of time for which the money is borrowed or lent. The time expressed in years
or fractional part of a year is the period between the loan date-the date when the loan was obtained
and maturity date-the date when the loan becomes due. In the illustration, the time is one year.
Compound Interest
- Means that the interest is computed more than once during time period of the loan.
Compound Interest loans are generally for time periods of a year or longer.
Concept of Time
The time T in the simple interest formula I=PRT is the period between the loan date and the
maturity date.
If the time in YEARS is not exact, say, 1 year and six months (1 and 6/12 or 1 and ½) it needs
to be converted. Therefore, 1 year and six months is 1.5
In other cases, the time T may be given in months or days, but still it needs to be converted to
decimal at an annual rate.
Cases when Time T is stated as a certain number of days. There are 2 METHODS at hand;
1.) Exact Interest Method – which uses 365 days as the time denominator (if it’s a leap year then
it should be 366 days.)
2.) Ordinary Interest Method – which uses 360 days as a time denominator
Problem Solving:
If Esperanza borrowed at P140,000 at 7% interest for 64 days, how much would the interest be using
Time Denominator
Exact Interest Method
Interest = Principal x Rate x Time
Interest = 140,000 x .07 x 64
