A.GRADE 11 RE Ce Pa ete ity GRADE 11 REVISION In Grade 12 itis essential that you fully understand the Grade 11 concepts of simple and compound growth and decay (interest and depreciation), as well as the concept of nominal and effective interest rates. a Recap of Grade 11 Formulas: Simple Interest: A=P(1+i2) | Compound Interest: A=P(1+i)" Simple Decay: A= P(1-in) Reducing Balance: A =P(1-i)" Example 1; How long must any amount of money be invested for, in order for it to double at an interest rate of 8,5% p.a simple interest. Give your answer in years and months. Simple interest: A=P(I+in) Let the initial amount invested be x. Therefore the final amount will be 2x: 2x =x(1+0,085n) > interest must be in a decimal . 2=1+0,085n — both sides were divided by x 0,085n 11,76... years > multiply 0,76... by 12 to obtain the number of months in 0,76 years -.It would take 11 years and 10 months before the money doubles. It is important to note that in the above example, although 0,76x12=9,12 months, after 11 years and 9 months the money still has not doubled. This is the reason for rounding up to 10 months. Example2: A computer server valued at R24 000 depreciates at 18% p.a. on a reducing balance. Determine the value of the server after 2 years. Reducing Balance A=P(I-i)" =24000(1-0,18)? — interest must be in a decimal =RI16137,60 © Copyright Kevin Smith / Berlut Books CC 51NOMINAL AND EFFECTIVE INTEREST RATES ‘The nominal interest rate is the rate that is quoted in the question. The effective interest rate is the equivalent annual interest rate that you would receive once compounding has been taken into account. Example: Given an interest rate of 12% p.a. compounded monthly: a) Determine the effective interest rate. b) Using the effective interest rate, convert an interest rate of 12% p.a. compounded monthly to an interest rate of 12% p.a. compounded quarterly. a) Vie =(I++ im)" b) 1+ ie = (1 inom)" 4 Stig = (1-02)" 01268 =(1+- — quarterly 0,12)? Boa: th . let = 1+. 12 = Lk Al 01268 Som root both sides a = 011268 =12, 68% thom. = f1+0,1268 — 4 “gm = 01212 =12,12% p.a. compounded quarterly ~Srom In Grade 12 you will be required to convert interest rates from one compounding period to a different compounding period as you did in the question above. The formula below provides a quick method of doing this. Formula: (1+inew J” = (1+ ¥nom)" Where: i,,,, —> interest rate with new compounding period ingm —> interest rate given in question (original compounding rate) n ->Number of time periods at the original compounding rate m —>Number of time periods at the new compounding rate Example: Convert an interest rate of 12% p.a. compounded monthly to an interest rate compounded quarterly. (1+ naw)" = (+ inom)” 4 2 + {tela (1-42) — quarterly to monthly 2 ctwige = (1422) — 4" root both sides new ( oun)" ew 14] 4 Wt ing = 01212 =12, 12% p.a. compounded quarterly ‘© Copyright Kevin Smith / Berlut Books CC 52TIME LINES It is useful to draw a timeline for problems where there is a change to the interest rate as well as problems where there are additional withdrawals and/or deposits which are not made on a regular basis. Example 1: R2 850 is invested at 8% p.a. compounded quarterly for 15 years. After 9 years the interest rate changes to 10,5% p.a. compounded monthly. How much is the investment worth after 15 years? i R%eg ni 10.5% cm 7 iTe Ths oo +2850 2 eyez “AS 2sso( 1-208)" foe) > 10,5% c.mis eamed for 6 years =R10885,95 Example 2; Ted invests R10 000 into an account that offers an interest rate of 3,25% p.a. compounded quarterly. After 2 years he deposits an additional R2 500 into the account and 3 years later withdraws R5 000. How much will he have in his account after 10 years? 3.25% eq i< >i mr EB UD Bh uw GF Bh Ty + —t + + + 10000 +2500 5000 2 x4 Six A= roo 120225 °° +2s00(1+ 20025) ~sonn{ 1+ 20828) =R11 182,68 Example 3: x Rand is invested into an account offering an interest rate of 12% p.a. compounded monthly. 3 years later 2x Rand is deposited into the account, After 7 years there is R27 655,87 in the account. Determine the value of x. 12% om Io nnn van oan PUREED ft © hf Rh H ty x +e 27655,87 7x12, 4x12 aressa7= {1 l2) 2,(14 a2) take out a HCF of x 12 ay? «.27655,87 = x] io +1492) 12 12 27655,87 Talz 1 (422 4214222) 12 12 ‘© Copyright Kevin Smith / Berlut Books CC 53USING LOGARITHMS TO DETERMINE THE TIME PERIOD In Grade 12 you will be expected use logarithms to determine the period of an investment or a loan. Example 1: An investment of R25 000 grows to an amount of R55 267,04. If the account offers an interest rate of 12% per annum compounded annually, for how long was the money invested? Method 1: Using the definition of the logarithm A=P(I+i)" <.58267,04 =25000(1+0,12)" —» divide both sides by 25000 <.2,2106816 = (1+ 0,12)" — do not round off during calculations *. = 108 (440,12) (22106816) =7 years — as interest is compounded annually n is in years Method 2: Using the laws of logarithms A=P(I+i)" -.55267,04=25000(1+ 0,12)" — divide both sides by 25000 <.2,2106816 = (1+0,12)" — 'log" both sides <-log (2,2106816) = log (1+0,12)” > use log law 3 on page 43 log (2,2106816) = n log (1+0,12) _ log(2,2106816) log (1+0,12) «n= years — as interest is compounded annually n is in years Method 1 above is recommended and will be used throughout the remainder of this textbook. However, you may choose whicheyer method you prefer. As an exercise, complete example 2 using method 2 as well. Example 2: A motor vehicle which costs R250 000 depreciates at rate of 3,8% per annum compounded monthly. How long will it take for the vehicle to be worth R206 677,47? A=P(1-i)" 1. 206677,47 = 2so00n(1-20°8) > divide both sides by 250000 -.0,82670988 = (-233) + do not round off during calculations ane Wf, oa) (0,82670988) LR :.n= 59,999... months —> as interest is compounded monthly n is in months c.m=5 years © Copyright Kevin Smith / Berlut Books CC. 54B. FUTURE VALUE AND PRESENT TZ: In Grade 12 you will learn two new concepts in financial mathematics: 1. Future Value Calculations 2. Present Value Calculations 1, FUTURE VALUE CALCULATIONS Future value calculations are used when a certain amount of money is placed into an account on a regular basis in order to save money. Therefore, future value calculations are used for: e Retirement annuities © Savings accounts (where equal deposits are made at regular set intervals) e Sinking funds Example 1; Equal payments of R500 are made into a savings account at the end of every month for 1 year. If the account offers an interest rate of 5,5% per annum compounded monthly, how much will have accumulated in the account after 1 year? 1 2 3 4 5 6 7 8 9 10 Il , month , months , months , months , months , months , months , months , months , months , months , <—_— e oe ses oe 31 2s git 30% 31 30" 3 31 3031 30H SI Jan Feb Mar Apr May ~—June—‘SJuly Aug Sept Oct Nov Dee i a 4 +500 +500 +500 +500 +500 +500 +500 +500 +500 +500 +500 +500 It is important to realise that the above scenario forms a geometric series: © The last deposit on the 31° of December will earn no interest © The 11" deposit on the 30 November will carn interest for 1 month © The 10" deposit on the 31 of October will eam interest for 2 months © This pattern continues until you arrive at the 1“ deposit which cams interest for 11 months The geometric series is represented below starting from the last deposit. Interest for cach term is calculated using the formula A= P(1+i)": 500 +500) +2022) s0o[ 1+ 205 assy so 500(14 last deposit Ti deposit 10 deposit 1 deposit This forms a geometric series with 12 terms and r -(1« us a0) and a=500. =R6153,58 © Copyright Kevin Smith / Berlut Books CC. 55DERIVATION OF THE FUTURE VALUE FORMULA In order to derive a formula which can be used for problems when deposits are made on a regular basis, let us look at the case where x Rand is deposited » times into a savings account at the end of every period offering an interest rate of i. This will form the geometric series shown below starting with the last deposit. x+x(1+i)'+x(1+i)? +2 (14d) +x(148)* +04 (148) +x(143)" This forms a geometric series with 1 terms and r=(1+i) and a=. af *-1] ral : «[aiy'-1] 14¢-1 >[a+a*-1] i Q The derivation of the future value formula is not examinable. Formula: i Where: F — Future value x —> Value of the instalment (usually paid monthly) i — Interest rate (not in a percentage) n -» Number of payments (deposits)/ number of compounding periods It is important to take note that the above future value formula can only be @ used if payments (deposits) are made at the end of a period and end after n periods. Unless otherwise stated, you may assume that payments begin at the end of a period. ‘© Copyright Kevin Smith / Berlut Books CC 56Example1: A company will require a new delivery truck in 3 years which is expected to cost R250 000. In order to ensure that the company has enough money to purchase the truck, they start a sinking fund which earns an interest rate of 7,5% per annum compounded monthly. Determine the amount that the company must invest every month in order to ensure that they can purchase the new truck. ye \ 3X12 (140008) Ly 250000+ 2.x =R6214,05 @ A sinking fund is a savings account which is set up in order to save money to replace an item sometime in the future. Do not round off during financial mathematics calculations. You may only round off at the end of each question. Example2: A company purchases a new vehicle for R200 000. The vehicle is expected to depreciate at a rate of 24% p.a. on a reducing balance. It is expected that the vehicle will have to be replaced after 5 years. A sinking fund is set up for this purpose. If the replacement cost of the vehicle increases by 18% p.a. compounded annually, calculate: a) the value of the current vehicle after 5 years b) the cost of a new vehicle after 5 years ¢) the total required value of the sinking fund, if the old vehicle is sold and the proceeds contribute towards the new vehicle d) the monthly instalments paid into the sinking fund if the interest rate is 15% p-a. compounded monthly and payments start 1 month after the vehicle is initially purchased. © Copyright Kevin Smith / Berlut Books CC 57a) Reducing balance: A=P(I-i)" = 200 000(1-0,24) =50710,51 <. The vehicle will be worth R50 710,51 after 5 years s b) Compound interest: A=P(I+i)" = 200 000(1+0,18)° = 457 551,55 «. The cost of a new vehicle will be R457 551,55 c) Sinking fund value = cost of the new vehicle—value of the old vehicle = 457 551,55-50710,51 = 406 841,04 ~. The value of the sinking fund has to be R406 841,04 *, ¥=4 593,21 ©. The monthly instalments are R4 593,21 © Copyright Kevin Smith / Berlut Books CC 58Example 3: Harry wishes to start saving for his retirement. He estimates that he will need R4000000 in order to retire comfortably. He invests R5000 a month at an interest rate of 13% per annum, compounded monthly. How many years will he have to wait to retire? — interest is compounded monthly ~eonoeo 222) se) =| 12 12 130.000 _ Soo9 14.013 “1 > 4000 o00{ 923 = 520.000 _ 130000 3 12 12 12 3 29 0,13)" i i aces — convert from exponential to log form aa a (F) sine then n =log, (y) we) =210,55—> number of payments ember of ya te en ne 28S =17,54 = 18 years Example 4: Solomon inyests R800 into a savings account every month. If the annual interest rate is 12,5% compounded monthly, how much will he have after 6 years? a{(i+i)"=1| i 72 800] (19228) -1 12 0,125 12 “. F=85 156,10 ~. After 6 years he will have R85 156,10 Investment : F = Fa >in 6 years 72 payments are made © Copyright Kevin Smith / Berlut Books CC 59Example 5: Ndumi starts a 5 year savings plan. He deposits R5 000 into a savings account at the end of every month. The interest rate on the account is 6% per annum compounded quarterly. a) Determine the nominal monthly interest rate which Ndumi receives. b) Determine the amount Ndumi will receive at the end of the 5 year period. a) (Itjney)” = (14+ inom)" , ye 06! (+4) -(142%8) > quarterly to monthly iggy = 0,0597 ine = 5,97% p.a. compounded monthly b) As deposits are being made monthly you have to use the monthly interest rate: FG +i)" -1| i 0 5000] (1-207) A 12 0,0597 12 Investment : F = —> use the monthly rate, 60 payments are made . F =R348581,33 .. After 5 years he will have R348 581,33 | @ Interest has to be compounded at the same rate as the payments. © Copyright Kevin Smith / Berlut Books CC 60Example 6: Ahmed deposits R2 000 into a savings account at the end of every quarter for 16 years. The account offers an interest rate of 8,5% p.a. compounded quarterly. Due to financial difficulty he is unable to make his last two payments. How much will he have in his account after 16 years? In 16 years 64 deposits should be made. However, the last 2 deposits are missed and only 62 deposits are made. a{(1+i)" -| i 62 20162085) “1 0,085 4 «. F =R252506,9461 — this is the amount in the account after 62 deposits Investment : F = 2 F= +2 deposits are missed This amount will still accumulate interest for 2 quarters: 2 A=P(1+i)" 0,085 2 thi =252505 9461(14.208°) — 2 quarters + A=R263352,51 +. He will have R263352,51 after 16 years | @ Do not round off during calculations in financial mathematics. ‘© Copyright Kevin Smith /Beslut Books CC 61Example 7: At the beginning of January a factory purchases a new delivery truck which they expect to replace in 5 years’ time. In order to replace the truck the company will need R200 000 after trading in the current vehicle. What monthly payments must be made into a sinking fund which provides an interest rate of 6,25% p.a. compounded monthly, if payments start 4 months after the original vehicle is initially purchased? In normal sinking fund calculations, the first payment is made one month after the purchase of the vehicle. In this case payments start 4 months later, which is at the end of April (beginning of May). It can be seen from the timeline below that 3 payments are missed as payments start when the 4" payment would usually be made. Ha pert ‘would normally First Payment bbe made here : month * 2 months 3 months 4 months “ ° ns sary January February March April Bist 28th Het 30th, Missed. Missed Missed payment payment payment 3 payments are missed 0,0625 0,0625)° = 2000 ay (2) 37 x= r0000( 2968 S)( ay -| x= 3022,73 .. The monthly payments are R3022,73 per month Pee Complete Exercise 1 on page 85. © Copyright Kevin Smith / Berlut Books CC 62HANDLING PAYMENTS MADE AT THE BEGINNING OF THE PERIOD As you have seen, the future value formula only applies to cases where payments are made at the end of a period. Should the first payment be made at the beginning of a period, the formula has to be adjusted to take this change into account. Example1: An amount of R500 is deposited at the beginning of every month starting on the Ist of January and ending on the I* of December. Determine the amount that will be in the account at the end of the year if the account earns an interest rate of 10% per annum compounded monthly. Using n=12 will give the amount in the account on the Ist of December 1 2 3 4 5 6 7 8 9 0 Ni 2 month , months, months, months months, months, months, months, months, months, months: months, ee vee opt ght ge ge gest gage st gst Jan Feb Mar Apr May June July Aug Sept Oct Nov Dec Dec F + + + + — + + +500 +500 +500 +500 +500 +500 +500 +500 +500 +500 +500 +500 As payments are made at the beginning of the month, using n = 12 in the future value formula will provide the amount in the account on the 1° of December. However, you are asked for the value in the account at the end of December. This means that you have to add one month's interest to the value in the account on the 1 of December. [(+iy"-1] i Ge ua 1 12 0,1 12 .. F =R6282,784046 — this is the amount in the account on the This amount will still accumulate interest for | month: Investment : F = Fs 912 deposits are made 1 of December A=P(1+i)" — P is the amount in the account on the 1 of December 1 nAS sao, 7840461 +4) 1 month «A= R6335,14 This can be combined into one step as shown below: 12 500] (+93) -1 12 0, Peg 12 R6335,14 In the future value formula, n is the number of payments that are made. 5 Interest is earned for 1 period less than the number of payments. This is because in the formula, itis assumed that no interest is earned on the last payment. © Copyright Kevin Smith / Berlut Books OC. 63Example 2: Arshad's birthday is on the 1* of January. On the day he turns 20 he starts to save for his 21° birthday party by placing R200 into a savings account every month with his last payment being made on his 21% birthday. How much money will Arshad have for his party, if the account promises an interest rate of 4,5% per annum compounded monthly and his party is to be held on the 1 of February? Using n=13 will give the amount in the account on the Ist of January 1 2 3 4 5 6 7 8 9 0 nN Bi: , month, months, months months months months months, months months months, months, months::months, ee i i i ee weeks se ste ge ge eget Jan-Feb Mar Apr May June July Aug Sept Oct Nov Dec Jan Feb be +200 +200 +200 +200 +200 +200 +200 +200 +200 +200 +200 +200 +200 The 1* deposit is made on the 1 of January and the last deposit is made on the 1* of January the next year. This means 13 payments are made. However, the money was left in the account for 1 extra month which has to be added to the amount in the account on 1* of January. af (14i)"- Investment : F = pat aah i is 200) (1-288) = ; 0,045 mle] {1000} 12 1 F =R2669,28 By using n=13 you are calculating the amount that would be in the account on the 1* of January (13 payments 12 months interest). As you 2 are looking for the amount that would be in the account on the 1* of February you have to add on 1 month's interest. This is achieved by multiplying the final amount by (1+i)'. © Copyright Kevin Smith / Berlut Books CC. 64Example 3: Sheryl's birthday is on the 1 of January. On the day she turns 20 she starts to save for her 21% birthday party by placing R200 into a savings account every month with her last payment being made on her 21* birthday. How much money will Sheryl have for her party on her birthday, if the account promises an interest rate of 4,5% per annum compounded monthly? 4 5 6 7 8 9 10 i 12 month months, months, months, months, months, months, months, months, months, months, months, “ow ge mw dé ode We ga ae de Geode pe Jan Feb Mar Apr May June July Aug Sept Oct Nov Dec Jan i + + a, 4200 +200 +200 +200 +200 +200 4200 +200 +200 +200 +200 +200 +200 In this case, 13 payments are made and interest is earned for 12 months. This is a normal future value calculation for an investment of 13 months. xf (1+ | Investment : F = 0,045)" a (14228) 5 12 2 F=R2659,31 Pe Complete Exercise 2 on pages 85 and 86. © Copyright Kevin Smith / Berlut Books CC 65