Financial Markets

Brennan John Rivera, CPA

44
 Table of Contents
Module 4 Simple Interest and Simple Discount
Introduction 46
Learning Outcomes 46
Lesson 1 Simple Interest 47
Lesson 2 Ordinary and Exact Interest 49
Lesson 3 Actual and Approximate Time 51
Lesson 4 Interest Between Dates 54
Lesson 5 Amount & Present Value at Simple Interest 56
Lesson 6 Simple Discount 59
Lesson 7 Promissory Notes 61
Assessment task 4 65
Summary 66
References 67
Module 5 Compound Interest
Introduction 68
Learning Outcomes 68
Lesson 1 Comparison of Simple and Compound Interest 68
Lesson 2 Accumulation Factor Method 70
Lesson 3 Law of Exponents 74
Lesson 4 Approximate Accumulation Method 75
Lesson 5 Present Value and Compound Discount 78
Lesson 6 Discounting Factor Method 78
Lesson 7 Approximate Discounting Method 80
Lesson 8 Finding Time by Linear Interpolation 83
Lesson 9 Finding Rate by Linear Interpolation 83
Lesson 10 Nominal and Effective Rates 87
Assessment task 5 92
Summary 93
References 94
Module 6 Simple Annuities
Introduction 95
Learning Outcomes 95
Lesson 1 Types of Annuities 95
Lesson 2 Finding the Interest Rate of an Annuity 101
Lesson 3 Finding Term of Annuity 104
Assessment task 6 107
Summary 109
References 110
Module 7 Amortization and Sinking Fund
Introduction 111
Learning Outcomes 111
Lesson 1 Finding the Outstanding Principal 112
Lesson 2 Amortization of a Debt 114
Lesson 3 Sinking Fund 119
Assessment tasks 7 121
Summary 123
References 124

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 MODULE 4
SIMPLE INTEREST AND SIMPLE DISCOUNT

Introduction

When people need to secure funds for some purposes, one of the ways they usually resort
to is borrowing. On the other hand, the people or institution which lends the money would also
wish to get something in return for the use of money. The person who borrows money for any
purpose is a debtor or maker, and the person or institution which loans the money is the
lender.

The payment for the use of borrowed money is called interest. The capital or sum of
money is invested is called the principal. The fractional part of principal that is paid on the loan
is the rate of interest and is usually expressed as percent. The time or term of the loan is the
number of units (days, months, years) of the time for which money is borrowed and for which
interest is calculated. The sum of the principal and the interest which is accumulated at a
certain time is referred to as final amount of maturity value. The amount received by the
borrower is the present value or proceeds of the loan.

This module presents the two types of interest: the simple interest and the compound
interest.

Learning Outcomes
At the end of this module, students should be able to:

1. define and explain the meaning of simple interest and simple discount
2. differentiate the two types of interest.
3. compute actual interest of borrowed money during a specified period of time
4. confer the importance of promissory note in a financial market

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Lesson 1. Simple Interest (Capitulo et al. 1990)

It is defined as the product of principal, rate and time. I=P x r x t where:

I = simple interest
P = principal in pesos
r = rate or percent of the principal which is to be paid per unit of time
t =units of time usually expressed in years or fractional parts of a year

Other formulas can be derived from the above.

Final Amount formula:
F =P+I
I =F–P

Commonly, in business, the interest rate is expressed as percent. In computing the

interest, it is necessary to convert the ratio into a fraction or decimal such as 6%= 6/100 or
0.06
The term of the loan is the period during which the borrower has the use of all or part of
the borrowed money. The term or time may be stated in any of the following ways:

1. When the time is expressed in number of year(s), our formula will be:
I = P x r x number of years(s)
2. When the time is expressed in number of month(s)
I = P x r x number of month(s)
12
3. When the time is expressed in number of days there are two (2) ways of
computing
interest, namely: (Details on 1.2)
a. Ordinary Interest (Io)
Io = P x r x number of days
360
b. Exact Interest (Ie)
Ie= P x r x number of days
365

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 4. When the time is expressed between dates, there are four (4) ways of computing
interest, namely: (Details o 1.4)
a. Io-Act. Time = P x r x Actual number of days*
360
b. Io-App. Time = P x r x Approximate number of days*
360
c. Ie-Act. Time = P x r x Actual number of days*
365
d. Ie-App. Time = P x r x Approx. number of days*
365
Known as the Banker’s rule, this is the formula being applied by banks in computing the
interest on savings deposit.

Let us work on the following examples to illustrate the application of the formulas.

Illustrative Examples

1. Find the interest and amount on 550 at 5 ½% simple interest for 4 years
I =Pxrxt F =P+I
= 550 x .005 x 4 = 550 + 121
= 121 = 671

2. Find the interest and amount on 1,500 at 6 ¼% simple interest for 10 months
I =Pxrxt F =P+I
= 1,500 x .0625 x 10/12 = 1500 + 78.12
= 78.12 = 1,587.12

3. Find the interest and amount on 850 at 4 ¾% simple interest for 3 years and 7 months
I =Pxrxt F =P+I
= 850 x .0475 x 3 7/12 = 850 + 144.68
= 144.68 = 994.68

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4. If a principal of 1,250 earns interest of 172 in 2 years and 9 months, what is the interest
rate, is in effect?
r = I
Pt
= 172
1250 x 2.75
= 5%

5. A principal earns interest of 196 in 3 years and 6 months at a simple interest rate of 6 ½%.
Find the principal invested
P = I
rt
= 196
0.2275
= 861.54

6. How long it will take for 800 to earn 240, if it is invested at 6 ½% simple interest?
t =I
Pt
= 240
800 x .065
= 4.62 years or 4 years and 7 months

7. Jessie Mae borrowed 12,500 from a bank at 9 ½ % simple interest for 3 years and 6 months.
How much did Jessie Mae pay back the bank?
I =Pxrxt F =P+I
= 12,500 x .09 x 3.5 = 12,500 + 4,156.25
= 4,156.25 = 16,656.25

Lesson 2. Ordinary and Exact Interests (Capitulo et al. 1990)

There are instances when the time for which a certain amount of money is borrowed is
given in number of days. In such case, it is necessary to change the number of days to a
fractional part of a year when substituting in the simple interest formula. If the interest is

49
computed with a denominator of 360, the interest is called ordinary (Io) and if the denominator
is 365, the interest is called exact (Ie).

Note:
a. Ordinary interest is greater than exact interest
b. When interest (ordinary or exact) is not specified in any problem it is assumed as
ordinary

Illustrative Examples:

1. Find the ordinary and exact interest on 5,500 for 95 days at 5 3/8% simple interest.
Io = P x r x number of days
360
= 5,500 x .05375 x 95/360
= 78.01
Ie = P x r x number of days
365
= 5,500 x .05375 x 95/365
= 76.94
2. Find the ordinary interest and amount on 6,000 at 6 1/2 % simple interest for 125 days
Io = P x r x number of days F =P+I
360 = 6,600 + 148.96
= 6,600 x .065 x 125/360 = 6,748.96
= 148.96
3. Find the exact interest and amount on 7,700 for 210 days at 7 1/8% simple interest.
Ie = P x r x number of days F =P+I
365 = 7,700 + 315.65
= 7,700 x .07125 x 210/365 = 8,015.65
= 315.65

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Lesson 3. Actual and Approximate Time
(Capitulo et. al 1990)

When the time is expressed between two dates, it is necessary to determine the actual
and approximate time.
Actual time is the exact or actual number of days in any given month
Approximate time where all the months within a year contain 30 days

Let us work on the following to show how to determine the actual and approximate time.
Illustrative Examples:
1. Find the actual and approximate time from April 21, 1991 to October 4, 1991

Table 4.1. Sample data on Approximate Time (Part 1)

Actual days Month Approx. days
9 April 9
31 May 30
30 June 30
31 July 30
31 August 30
31 September 30
4 October 4
166 days 163 days

Alternative Solution:

Actual Time (Table 1)

April 21 = 111
October 4 = 277
Difference = 166 days

Approximate Time (Express the dates in numerals)

April 21, 1991 =4 - 21 - 91

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 October 4, 1991 =10 -4 - 91
(34)
(9) (30)
91 - 10 -4
91 -4 -21
5 - 13
x 30
150 + 13 = 163 days

2. Find the actual and approximate time from May 6, 1990 to November 26, 1990.

Table 4.2. Sample Data on Approximate Time (Part 2)

Actual days Month Approx. days
15 May 14
30 June 30
31 July 30
31 August 30
30 September 30
31 October 30
26 November 26
194 days 190 days

Alternative Solution
Actual Time (Table 1)
May 16 = 136
November 26 = 330
Difference = 194 days
Approximate Time (Express the dates in numerals)
May 16, 1990 =5 - 16 - 90
November 26, 1990 =11 - 26 - 90
90 - 11 -26
90 -5 -16
6 - 10
x 30

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 180 + 10 = 190 days
3. Find the actual and approximate time from November 1, 1990 to March 23, 1991.

Table 4.3. Sample Data on Approximate Time (Part 3)

Actual days Month Approx. days
29 November 29
31 December 30
31 January 30
28 February 30
23 March 23
142 days 142 days

Alternative Solution:

Actual Time (Table 1)

November 1 = 305
December 31 = 365 Difference = 60
March 23, 1991 82
142 days
Approximate Time (Express the dates in numerals)

November 1, 1990 = 11 -1 - 90
March 23, 1991 =3 - 23 - 91
(15)

(90) (12)
91 -3 -23
90 - 11 -1
4 - 22
x 30
120 + 22 = 142 days

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4. Find the actual and approximate time from October 18, 1990 to May 10, 1991.
Actual days Month Approx. days
13 October 12
30 November 30
31 December 30
31 January 30
28 February 30
31 March 30
30 April 30
10 May 10
204 days 202 days

Alternative Solution
Actual Time (Table 1)
October 18, 1990 = 291
December 31, 1990 = 365
Difference = 74
May 10, 1991 =130
204 days
Approximate Time (Express the dates in numerals)
(16)
(12) (40)
(90) (4) (30)
91 -5 -10
90 - 10 -18
6 - 22
x 30
180 + 22 = 202 days
Lesson 4. Interest Between Dates (Capitulo et al. 1990)

In the previous cases, the time for which interest is calculated is directly between in
terms of years, months or days. In cases, when interest is to be computed from certain date
to another date inclusively, there are four methods of computations namely:

54
 a. Ordinary interest for actual time
b. Ordinary interest for approximate time
c. Exact interest for actual time
d. Exact interest for approximate time

Illustrative Examples:

1. Find the interest using the four methods on 5,000 at 5% interest from August 2, 1990 to
November 27, 1990.
Approximate Time Actual Time
1990 - 11 - 27 1990 - 11 - 27 = 331
1990 – 8 - 2 1990 -8- 2 = 214
3 25 117 days
x30
90 + 25 days = 115 days
a. Io-Act = 5,000 x 0.05 x 117/360 = 81.25
b. Io-App = 5,000 x 0.05 x 115/360 = 79.86
a. Ie-Act = 5,000 x 0.05 x 117/365 = 80.14
a. Ie-App = 5,000 x 0.05 x 115/365 = 78.77

2. Find the interest on 6,025 at 6 ¼% from November 20, 1989 to April 6, 1990 using the 4
methods
Approximate Time Actual Time
(12) (36)
1989 (3) (30)
1990 - 4 - 6 1989 - 11 - 20 = 324
1989 –11 - 20 1989 - 12 - 31 = 365
4 16 Difference 41 days
x30 4 – 6 – 90 96
120 + 16 days = 136 days 137 days
a. Io-Act = 6,025 x 0.0625 x 137/360 = 143.30
b. Io-App = 6,025 x 0.625 x 136/360 = 142.26
a. Ie-Act = 6,025 x 0.0625 x 137/365 = 141.34

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a. Ie-App = 6,025 x 0.0625 x 136/365 = 140.31

Lesson 5. Amount and Present Value of Simple Interest (Capitulo

et al. 1990)

At the end of the term for which interest is to be computed, the amount due a lender is the
sum of the principal and interest and is designated by the symbol (F). This is called final
amount or maturity value and is given by the formula.
F =P+I
F = P + Prt
by factoring, we have F = P (1+rt)

a. Accumulation is the process of determining the amount F of given principal P due at a

specified time t. To accumulate a principal P for t years means to solve for the final amount
by applying the formula F= P (1+rt)

Illustrative Examples:
1. A businessman borrows 4,200 for 3 years at 5 ½% simple interest. What amount must he
pay?
F = P (1+rt)
= 4,200 (1+0.055 x3)
= 4,200 (1.165)
= 4,893

2. Accumulate 4,080 for 10 months at 7 2/5% simple interest

F = P (1+rt)
= 4,080 (1+.074x 10/12)
= 4,080 (1.061667)
= 4,331.60

3. Accumulate 5,500 for 2 years and 3 months at 5 3/8% simple interest.

F = P (1+rt)
= 5,500 (1+.05375x 2 3/12)

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 = 5,500 (1.120938)
= 6,165.16
4. Accumulate 3,490 for 110 days at 4 ½% simple interest
F = P (1+rt)
= 3,490 (1+.045x 110/360)
= 5,500 (1.013750)
= 3,537.99

5. Accumulate 2,500 at 5 3/5% simple interest from November 6, 1988 to April 11,1989
Actual Time (Table 1)
Nov. 6, 1988 310 F = P (1+rt)
Dec.31, 1988 365 = 2,500 (1+.056x156/360)

Difference 55 = 2,500 (1.024267)

Apr 11, 1989 101 = 2,560.67
156 days

B. Discounting is the process of determining the present value of any amount due in the future.
To discount on amount F for t years means to solve for P applying the formula
P =F
(1+rt)

Illustrative Examples:

1. Discount 3,250 for 2 years at 4% simple interest.

P =F
(1+rt)

= 3,250
(1+0.04 x2)
= 3,009.26

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2. Discount 4,109 for 3 years and 9 months at 5 ½% simple interest
P =F
(1+rt)
= 4,109
(1+0.055 x 3 9/12)
= 4,109
(1.206250)
= 3,406.42
3. Discount 5,900 for 11 months at 4 4/5% simple interest
P =F
(1+rt)
= 5,900
(1+0.048 x 11/12)
= 5,900
(1.044)
= 5,651.34
4. Discount 1,750 for 115 days at 4 7/8% simple interest
P =F
(1+rt)
= 1,750
(1+ 0.04875 x 115/360
= 1,723.17
5. Discount 6,400 at 6 1/5% simple interest from August 9,1989 to December 25 1989
Actual Time Table 1
Aug 9, 1989 =221
Dec 25, 1989 =359
Difference 138 days
P =F
= 6,400
(1+0.062 x 138/360)
= 6,400
1.023767
= 6,251.42

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Lesson 6. Simple Discount (Capitulo et al. 1990)

A discount is a deduction from the final amount F or maturity value MV of a loan or

obligation. A simple discount is often called bank discount or interest in advance. The amount
of money that the borrower receives is called proceeds.

To elucidate the above concept, let us consider the case of Mr. Bokwa who wants to
borrow 4,500 for six months from a lender who charges 6 ¾% interest in advance. The lender
will deduct 6 ¾% of 4,500 or 303.75 which is called amount of discount or simply called bank
discount, and Mr. Bokwa will receive 4,196.25 which is called the proceeds. Thus, the
computation of bank discount is based on the final amount or maturity value rather than the
present value.

The discount rate for a given period of time is the ratio of the discount for the period to
the maturity value or final amount.
Interest in advance or bank discount can be computed by means of the formula
D =Fxdxt
D =Discount
F =Final amount
d = discount rate
t = time or term of discount
Present Value Formula P = F-D or P = F(1-dt)
Final amount formula F =D
(1-dt)
Illustrative Examples
1. Mr. Kopak borrowed 4,800 for 9 months from Ms. Jawo who charged 5 ¾% simple
discounts. How much money did Mr. Kopak receive?
D=Fdt P=F-D
= 4,800 x 0.0575 x 9/12 = 4,800-207
= 207 = 4,593
2. How much loan would Mr. Kamlon ask for if he needs 2,500 cash which will be repaid in 1
year and 3 months with 5 4/5% simple discount?
F =P

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 (1-dt)
= 2,500
(1-0.058 x 1 3/12)
= 2,500
.9275
=2,695.42
3. How long it will take for 3,870 to amount 5,695 if the discount rate is 5 3/5%?
D = F-P t =D
= 5,695-3,870 Fd
= 1,825 = 1,825
5,695 x 0.056
=5.72 years
4. If the proceeds of a loan of 2,450 will be paid with 2,840 at the end of 1 year and 3 months,
what is the simple discount rate?
D = F-P d =D
= 2,840-2,450 Ft
= 390 = 390
(2,840 x 1 x 3/12)
=10.99%
5. Accumulate 5,800 for 4 years and 9 months at 6 3/8% simple discount.
F =P
(1-dt)
= 5,800
(1-0.06375 x 4 9/12)
=8,319.13
6. Discount 6,400 for 5 years and 6 months at 5 7/8% simple discount
P = F(1-dt)
= 6,400 (1-0.05875 X 5 6/12)
= 4,332

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Lesson 7. Promissory Note (Capitulo et al. 1990)

Promissory note is a written promised signed by the maker or debtor to pay a certain
sum of money on demand or at a fixed determinable future date, either to the bearer or to the
order of a designated person. A promissory note is a negotiable financial paper, it can be sold
to a bank or lending agency at a specified discount rate.

The important features of a promissory note are the following:

1. Face value of the note – the amount of the note borrowed
2. Date of note (Dn) – the date the note was written
3. Maturity date (Md) – the promised date of payment or due date
4. Interest rate (r) – the simple interest rate
5. Lender or payee -the person to whom payment is due
6. Maker’s signature – the borrower

Sample of a promissory note

5,000 Quezon City, August 1, 1990

One hundred twenty days after due date, I promised to pay to the order of Pamela Alfonso the
amount of Five thousand pesos (Php 5,000) plus interest at 5 ½% per annum
(Sgd.) Micaela Megia

When the holder of a promissory note finds himself in need of cash before the maturity
date, he may sell the note to other persons or to a bank. This procedure is called discounting
or selling the promissory note.

The amount at which a note is bought depends on the discount rate charged by the buyer,
usually less than the maturity date. The maturity value is the amount at the end of a given
term which is the sum of the face value FV and interest. A promissory note is either interest
bearing or non-interest-bearing note. If the note is non-interest-bearing, the maturity value is
the same as face value (MV=FV). The term of discount is the actual number of days (time)
from the discounting date until the maturity date. Bank discount is the amount to be deducted

61
to the maturity value. Proceeds is the sum a creditor is willing to pay a note before its maturity
date.
Notation:
FV = Face value Dn = Date of note
MV = Maturity value Dd = Discounting date
I = Interest Md = Maturity date
tn = term of note td = term of discount
r =Interest rate Bd = Bank discount
d =Discount rate P =Proceeds

Illustrative Examples:

1. A businessman has a note of 4,500 dated March 17,1990. The note is due in 120 days
with interest at 6 ¼%. If he sells the note on May 6, 1990 at a bank charging a discount
rate of 5 7/8%, find the I, MV, Md, td, Bd and P.
I = Fv x r x tn MV = FV + I
=4,500 x 0.0625 x 120/360 = 4,500 + 93.75
=93.75 = 4,593.75

Md = Dn + tn (Table 1)
= Mar 17, 1990 = 76
tn =120
196 days = July 15, 1990
td = Md-Dd (Table 1)
Md = July 15 =196
Dd =May 6 126
70 days
Bd = MV x d x td
=4,593.75 x 0.05875 x 70/360
= 52.48
P = MV- Bd
= 4,593.75-52.48
= 4,541.27

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2. A note of 3,700 dated November 27, 1990 will mature in 90 days with interest at 7 ½%. The
note is discounted on January 6, 1991 at a discount rate of 6 4/5%. What are the proceeds?
I = Fv x r x tn MV = FV + I
=3,700 x 0.075 x 90/360 = 3,700 + 69.38
=69.38 = 3,769.38
Md = Dn + tn (Table 1)
= Nov 27, 1990 = 331
tn =90
421 days
365 = Feb. 25, 1991
td = Md-Dd (Table 1)
Md = Feb 25, 1991 =56
Dd =Jan 6, 1991 6
50 days
Bd = MV x d x td
=3,769.38 x 0.068 x 50/360
= 35.60
P = MV- Bd
= 3,769.38-35.60
= 3,733.78
Alternate solution
MV = FV (1+r x tn)
= 3,700 (1+0.075x90/360)
= 3,700 (1.01875)
= 3,769.38
Proceeds = MV(1-dxtd)
=3,769.38 (1-0.068 x 90/360)
= 3,769.38 (0.990556)
= 3,733.78

2. A 4 month note dated July 4, 1990 with face value of 4,000 bears interest at 6%. The
note is discounted on September 13, 1990 at a bank whose discount rate is 5 3/5%.
Find the proceeds.

63
Md = Dn + tn (Table 1)
= Jul 4, 1990 + 4 months = November 4, 1990
td = Md-Dd (Table 1)
Md = Nov 4, 1990 =308
Dd =Sep 13, 1990 256
52 days
MV = FV (1+r x tn)
= 4,000 (1+0.06x4/12)
= 4,000 (1.02)
= 4,080.00
Proceeds = MV(1-dxtd)
=4,080 (1-0.056 x 52/360)
= 4,080 (0.9911911)
= 4,047

4. On June 26, 1991 Edith Cruz, obtains a loan from a bank to be repaid in December 18,
1991. If the bank charges 7 ¼% simple discount, what must be the face value of a non-
interest-bearing note that will have proceeds of 3,500?

td = Md-Dd
Jun 26, 1991 =177
Dec 18, 1991 = 352
Difference =175 days
F =P
(1-dt)

= 3,500
(1-.0725 x 175/360)
= 3,632.86
5. A note of 5,600 matures in 150 days with interest at 6 ¾%. The note is discounted 45 days
before maturity at a discount rate of 5 3/8%. What are the proceeds?
I = Fv x r x tn MV = FV + I

64
 =5,600 x 0.0675 x 150/360 = 5,600 + 157.50
=157.50 = 5,757.50

Bd = MV x d x td
=5,757.50 x 0.05375 x 45/360
= 38.68
P = MV- Bd
= 5,757.50-38.68
= 5,718.82

Assessment task 5

1. A businessman charges his client 2,750 on a loan of 15,800 for 2 years and 3 months. What
simple interest rate is he using?
2. Three months after borrowing money, David Tan pays on interest of 270. How much did he
borrow if the simple interest rate is 5 ½%?
3. Aselo borrows 17,000 on April 21, 1992 and repays the loan on April 21, 1994 with interest
at 5 1/8%. Find the amount repaid.
4. Find the ordinary interest on 2,100 for 65 days at 5 ¼% simple interest
5. Find the exact interest on 4,210 for 200 days at 5 1/5% simple interest
6. Find the ordinary and exact interest on 2,750 for 65 days at 4 1/8% simple interest
7. Find the actual and approximate time from June 26 to December 6 of the same year
8. Find the actual and approximate time from October 16, 1989 to March 23 1990
9. Find the actual and approximate time from December 19, 1990 to June 6, 1991
10. Find the interest on 4,570 at 5 ¾% from January 17, 1991 to July 7, 1991 using the four
methods
11. Using the four methods, find the interest on 6,700 from October 29, 1992 to March 10,
1993 at 7 5/8% simple interest
12. Find the ordinary interest and amount on 2,200 at 4 3/8% simple interest from September
9, 1990 to April 16,1991
13. Accumulate 2,050 for 6 years at 4 3/8% simple interest
14. Discount 6,850 for 3 years and 8 months at 4 5/8% simple interest

65
15. If money is worth 4 2/5% simple interest, what is the present value of 7,215 due in 4 year
and 7 months
16. A 90-day note promises to pay 6,500 plus simple interest of 6 3/4%. It is discounted at 5
4/5% simple discount 20 days before maturity. Find the maturity value of the note and the
proceeds of the sale.
17. A note dated October 16, 1991 has a face value of 5,900 and bears interest at 7 3/5% at
the end of 180 days. On February 1, 1991 it was discounted at 6 7/8%. Find the proceeds
18. L.A. Corporation holds the following interest-bearing notes. On February 14, 1990 they
are sold to a bank that charges 5 ½ simple discount. Find the total proceeds

Summary

 The person who borrows money for any purpose is a debtor or maker, and
the person or institution which loans the money is the lender.
 The payment for the use of borrowed money is called interest.
 The capital or sum of money is invested is called the principal.
 The fractional part of principal that is paid on the loan is the rate of interest
and is usually expressed as percent.
 The sum of the principal and the interest which is accumulated at a certain
time is referred to as final amount of maturity value. The amount received by
the borrower is the present value or proceeds of the loan.
 The term of the loan is the period during which the borrower has the use of
all or part of the borrowed money
 The four (4) methods in computing interest from certain date to another
dates are as follows: a. Ordinary interest for actual time; b. Ordinary interest
for approximate time; c. Exact interest for actual time; and
d. Exact interest for approximate time
 A discount is a deduction from the final amount F or maturity value MV of a
loan or obligation. A simple discount is often called bank discount or interest
in advance. The amount of money that the borrower receives is called
proceeds.

66
  Promissory note is a written promised signed by the maker or debtor to pay
a certain sum of money on demand or at a fixed determinable future date,
either to the bearer or to the order of a designated person.
 Accumulation is the process of determining the amount F of given principal
P due at a specified time

Reference

Capitulo, Florante & Cruz, Carmelita (1990) Mathematics of Investment 2nd Edition.
Manila, Philippines National Bookstore Inc.

MODULE 5
COMPOUND INTEREST

Introduction

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 Simple interest as a type of interest has been discussed in the previous chapter. The
present discussion will focus on compound interest as another type. Compound interest is the
interest resulting from the periodic addition of simple interest to the principal. When interest is
periodically added to the principal and this new sum is used as the new principal for a certain
number of periods, the resulting amount is called final or compound amount and is designated
by F. The time between successive interest computations is called compounding or
conversion period. The number of conversion periods for one year is denoted by m, while the
total number of conversion periods for the whole investment term is denoted by n. Conversion
periods are usually expressed by any convenient length of time, and usually taken as an exact
division of the year, such as monthly, quarterly, semiannually and annually.

Learning Outcomes
At the end of the chapter, students should be able to:

1. Differentiate simple interest and compound interest

2. Compute the compound amount by the 3 Methods
3. Find the time by linear interpolation
4. Find the rate by linear interpolation
5. Differentiate nominal and interest rate
6. Define equations of value and solve three methods of solving equations of value

Lesson 1. Comparison of Simple Interest and Compound

Interest (Capitulo et al. 1990)

To elucidate the concept of the above topic, let us compute the amount F or maturity
value of a note at the end of 3 years, if the principal P or face value isP800 and the interest
rate r is 6% compounded semiannually and compare compound interest with the simple
interest for the same conditions as stated.
Simple Interest
Original principal 800
Interest for the first year 48 (800 x 0.06)
Interest for the 2nd year 48 (800 x 0.06)

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 Interest for the 3rd year 48 (800 x 0.06)
Amount of the end of 3 years 944
Less the original principal 800
Total Interest for 3 years 144

Compound Interest
Given:
P P800; t= 3 years r=6% m =2

Solution:
n = txm i = r/m
=3 x 2 = 6%/2
=6 =3%

Original Principal 800

Interest for the 1st 6 mos. (800 x .03) 24
Principal at the end of the 1st 6 mos. 824
Interest for the 2nd 6 mos. (824 x .03) 24.72
Principal at the end of the 2nd 6 mos. 848.72
Interest for the 3rd 6 mos. (848.72 x .03) 25.46
Principal at the end of the 3rd 6 mos. 874.18
Interest for the 4th 6 mos. (874.18 x .03) 26.23
Principal at the end of the 4th 6 mos. 900.41
Interest for the 5th 6 mos. (900.41 x .03) 27.01
Principal at the end of the 5th 6 mos. 927.42
Interest for the last 6 mos. (927.42 x .03) 27.82
Amount at the end of 3 years 955.24
Less original principal 800
Total compound interest for 3 years 155.24

This shows that the compound interest P155.24 is more than the simple interest
P144.00 by P11.24

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 The above method is tedious and time consuming, for as the number of interest
periods increases, the arithmetical process becomes longer to perform. It behooves us
therefore, to use a compound interest formula which will provide us with a simpler and easier
solution in computing the compound amount.
The fundamental formula for compound amount is:
F=P (1 + i)"
I=F-P
where:
F= final or compound amount
P = original principal
i = periodic rate (i = f/m)
n= total number of conversion periods for the whole term (n= t x m)
I = compound interest

The compound amount may be computed by the following methods

I Accumulation Factor Method
II Law of Exponents Method
III Approximate Accumulation Method

Lesson 2. Accumulation Factor Method (Capitulo et al. 1990)

As mentioned in the previous lesson, accumulation of the principal P is the process

of finding the final amount F, and the simplest method in finding the compound amount is by
the use of accumulation factor method. In this method, we use Table 2 for the values of (1 +
i)" and table 4 for the values of (1 + i)". The procedure will be illustrated in the following
examples.

Illustrative Examples:
1. Find the compound amount and interest if P4,600 is invested at 8% compounded quarterly
for 5 years and 6 months.
Given:
P=P4,600; 1= 8%, m= 4; t= 5 yrs. & 6 mos.

70
 Solution:
i = 8%/4
n = 56/12 x4
= 2%
= 22
F = P (1 + i)
F = P4,600 (1 + 2%)
= P4,600 (1.545980) Table 2*
= 77,111.51

I= F-P
= P7,111.51 - $4,600
= P2,511.51
* The whole value of (1 + 2%) can be found in Table 2 by locating the intersection of Column
n and row i as illustrated below.
Table 2
Accumulation Factor Compound Interest
Values of (1 + i)"
n 2%

1 1.020 000
2 1.040 000
3 1.061 208

21 1.515 666
22 1.545 980
23 1.576 899
24 1.608 437
2. Accumulate P4,800 for 2 years at 7% converted monthly.
Given:
P= P4,800; r= 7%, m= 12; t = 2 years
Solution:
i = 7/12%

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 n = 2 x 12
= 24
F=P(1 + i)"
F = P4,800 (1 + 7/12%)24 Table 2
= P4,800 (1.149806)
= P5,519.07
3. What sum of money will be required to discharge a loan ofP7,800 on April 1, 1992, if the
loan is made on October 1, 1983 at a rate of 9% compounded quarterly?
Given:
P=P7,800; 1= 9%; m = 4
t = Oct. 1, 1983 to April 1, 1992
Solution:
i=9%/4
= 2 1/4%
(91) (16)
1992 - 4-1
1983 - 10-1
8-6 = 8 yrs. & 6 mos.
n=8 6/12 x 4
= 34
F= (1 + i)"
F=+7,800 (1 +2 1/4)34
= P7,800 (2.130849) Table 2
=P16,620.62

In the preceding illustrative examples, we computed the compound amount where the
number of conversion periods n is expressed as a whole number. Suppose we accumulate a
principal when the number of conversion periods n is not a whole number, but a fraction which
is expressible as 1/p.

Another accumulation factor table will be applied. (Table 4).

Let us work on the following to illustrate the application of the above.

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Illustrative Examples:

1. Accumulate 14,500 for 4 years and 8 months at 5 1/2% converted semi-

Given:
P=P4,500; r= 51/2%; m = 2; t=4 yrs. & 8 mos.
n = 48/12 x 2
= 9 13
Solution:
i = 51/2%/2
= 2 3/4%
Formula:
F=P(1 + i) " (1 + i)
Table 2 Table 4
F = 84,500 (1 +2 3/4%) (1 +2 3/4%)
= P4,500 (1.276546) (1.009084)
= P5,796.64

2. Find the compound amount and interest on P8,200 for 2 years and 3 months at 6%, m = 2.
Given:
P=P8,200, r=6%, m = 2; t=2 yrs.
Solution:
i = 6% 12 i = 3%; 1= 23/12 x 2
n=4 1/2
F = P(1 + i)" (1 + i)\
F = P8,200 (1 + 3%)*(1 + 3%)
= P8,200 (1.125509) (1.014889)
=19,366.59
I=F-P
= 19,366.59 -28,200
=21,166.59

Lesson 3. Law of Exponents (Capitulo et al. 1990)

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 This method is applicable when the interest rate or periodic rate is in the table but the value
of n is beyond the table limit. The procedure will be illustrated by the following examples.

Illustrative Examples:

1. Accumulate 500 at 5% compounded monthly for 20 years and 5 months

Given:
P=P500; r = 5%; m = 12; t = 20 5/12
Solution:
i = 5/12%
n = 20 5/12 x 12
= 245*
* 245 is beyond table limit.
F=P (1 + i)"
F=P500 (1 + 5/12%)200 (1 + 5/12%)45
=P500 (2.296996) (1.205760) Table 2
= P1,384.81

2. Find the compound amount and interest on P800 at the end of 30 years and 9 months, if
the interest rate is 6% converted quarterly.
Given:
P= P800; r =6%; m = 4; t = 30 yrs. & 9 mos.
Solution:
i = 6% /4
= 11/2%
n= 30 9/12 x 4
= 123*
* 123 is beyond table limit.
F=P(1 + i)"
F=P800 (1 + 1 1/2 %)100 (1 + 1 1/2%)
F = P800 (4.432046) (1.408377) Table 2
= P4,993.59
I= F-P

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 = P4,993.59 - 800
=P4,193.59

Lesson 4. Approximate Accumulation Method

(Capitulo et. al 1990)

When methods I and II cannot be put into application, the above method is the appropriate
process that can be applied. The combined application on tables 2 and 4 might lead us to
complexity of the arithmetical process. For instance, the rate is 6% converted semiannually
and the time is 2 years and 1 months, so i = 3% and n = 52/3, but 2/3 cannot be located in
tables 2 and therefore, at this point, the approximate accumulation method will be employed.
To illustrate this method, we present some working examples.

Illustrative Examples:

1. Accumulate P4,200 at 3 1/2 compounded semiannually for 3 years and 10 months.

Given:
P= P4,200; r= 3 1/2%;
m = 2; t = 3 yrs. & 10 mos.
Solution:
i = 3 1/2% 12
= 1 3/4%
n = 3 10/12 x 2
= 7 2/3*
7 2/3 cannot be located in tables 2 and 4, so it is necessary to determine the nearest
whole period. Thus, 3 years and six months is the nearest period plus 4 months. (See the
diagram below) n=36/12 x 2 n=7

Step 1 Accumulate P4,200 for 3 years and 6 months, at 3 1/2% compounded semiannually.
F= P(1 + i)"
F, = 14,200 (1 + 1 3/4%)?
F, = P4,200 (1.129122)
F, = P4,742.31

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Step II Compute the simple interest on the result of step I at the given interest rate for the
remaining time.
I = F,rxt
= P4,742.31 x .035 x 4/12
= P55.33

Step III Add the results of steps I and II to get the amount at the end of 3 yrs. & 10 mos.
F, = F, +1
= 24,742.31 +P55.33
= P4,797.64

2. Accumulate P3,500 at 5 1/2% compounded quarterly for 4 years and 11 months.

Given:
P=P3,500; 1= 5 1/2%; m = 4; t = 4yrs. & 11 mos.
Solution:
i = 5 1/2% /4
= 1 3/8%
n = 4 11/12 x 4
= 19 2/13
Whole period = 4 yrs. & 9 mos. + 2
n = 49/12 x 4
= 19
Step I
F, = P (1 + i)-
= P3,500 (1 + 1 3/8%)"
= P3,500 (1.296243)
= 24,536.85

Step II
I= F x r x t
= 24,536.85 x .055 x 2/12
= 241.59

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Step III
F = F, +I
= P4,536.85 + P41.59
= +4,578.44

3. Find the amount if 79,600 is invested for 3 years and 7 months at 4% m=1
Given:
P=19,600; r = 4%; m= 1; = 3 yr. & 7 mos.
=3+7
Solution:
i = 4%
n=3

Step I
F, = P (1 + i)"
=P9,600 (1 + 4%)
= P 9,600 (1.124864)
=+10,798.69
Step II
I= Fx r x t
= P10,798.69 x .04 x 7/12
=1,251.97

Step III
F, = F, +1
= 110,798.69 ++251.97
= P11,050.66

Lesson 5. Present Value and Compound Discount

(Capitulo et al. 1990)

In business transactions, it is necessary to determine the present value of a certain amount

of money due on some later date.

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 The present value is defined as the principal P which, if invested for the given time at a
given interest rate r, will amount to F on the date than F is due.

Compound discount D is the difference between the final

The values of (1 + i) - are found in Table 3. The alternative formula

The present value at compound interest is given by:
P=F(1 + i) -" D=F-P
P=F (1 + i)" Table 2

The present value may be computed by the following methods:

I Discounting Factor Method
II Law of Exponents Method
III Approximate Discounting Method

Lesson 6. Discounting Factor Method

(Capitulo et al. 1990)

Discounting the final amount is the process of finding the present value and the simplest
way is by the use of the discounting factor method. In this method, we use table 3 for the
values of (1+i)". The procedure will be illustrated by the following examples.

Illustrative Examples:

1. If money can be invested at 5 112% converted quarterly, find the present value of P5,600
due at the end of 3 years and 9 months.
Solution:
i = 5 1/2%/4
n= 3 9/12 x 4
= 1 3/8%
= 15
P = F (1 + i)-"
P = P5,600 (1 + 1 3/8%)-¹⁵

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 =25,600 (.814774) Table 3
= P4,562.73
Alternative Solution:
P = F /(1 + i)"
= P5,600 / (1 + 1 3/8%)¹⁵
= 5,600/(1.227335) Table 2
=P4,562.73

2. An obligation of 15,600 is due on January 6, 1994. What is the value of this obligation on
July 6, 1987 at 5 1/2% compounded semiannually?
Given:
F= P15,600; 1=5 1,2%, m=2; t=7-6-87 to 1-6-94 t = 6 yrs. & 6 mos.
Solution:
i=5 1/2%/2
n=66/12 x 2
= 2 3/4%
= 13
P=F(1 + i)
P = P15,600 (1 +2 3/4)-¹³
=P15,600 (.702807) Table 3
= P10,963.79

3. Discount P5,100 for 9 years and 9 months at 9% compounded monthly.

Given:
F = P5,100; r = 9%, m= 12; 1= 9 yrs. & 9 mos.
Solution:
i = 9%/12 n=9 9/12 x 12
= 3/4% n= 117

P = F(1 + i)-¹¹⁷
P = P5,100 (1 + 3/4%)-¹¹⁷
P = P5,100 (.417185) Table 3
P = P2,127.64

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Altemative Solution:
P =F /(1 + i)ⁿ
=P5,100/ (1 + 3/4%)¹¹⁷
=5,100/ (2.397019)
=P2,127.61

Lesson 7. Approximate Discounting Method

(Capitulo et al. 1990)

We have considered methods I and II of obtaining the present value. Method III
involves approximate discounting and it is applied, when the total number of conversion period
n is a mixed number, such as, n = 5 2/3 or 6 3/4.
The procedure will be illustrated by the following examples.

Illustrative Examples:
1. Discount P3,700 for 3 years and 10 months at 5% compounded quarterly.
Given:
F = P3,700; r = 5%; m = 4; t = 3 yrs. & 10 mos.
Solution:
i = 5%/4 n = 4x4
= 1 1/4% = 16 whole period containing 3 yrs. & 10 mos.
is 4 years minus 2 mos.
Step I Discount P3,700 for 4 years at 5%, m = 4.
P, = F (1 + i)-ⁿ
P, = 23,700 (1 + 1 1/4%)-16
= P3,700 (.819746)
= P3,033.06

Step II Compute the simple interest on the result of step 1 at the given interest rate for
the excess time.
I= P, x r x t
=13,033.06 x .05 x 2/12

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 = P25.28

Step III Add the results of steps I and II to get the present value at 3 years and 10
months
P2 = P, + 1
= P3,033.06 +125.28
= P3,058.34

Note: By scientific calculator the theoretical present value is P3,058.28

Discount P4,200 for 4 years and 1 month at 8% compounded semiannually
Given:
F=P4,200; r = 8%; m=2
t = 4 MTS, & 1 mo.
Whole period is 4 yrs. & 6 mos. minus 5. (4-6-5).

Solution:
i=8% 12 n= 4 6/12 x 2
= 4% =9

Step I P, = F (1 + i)-ⁿ
P, = P4,200 (1 +4%)-9
= P4,200 (.702587)
= 2,950.87
Step II I=P x r x t
= 22.950.87 2.08 x 5/12
= 98.36
Step III P, = P, +1
P = 22,950.87 +298.36
P =3.049.23

3. If money is worth 5% compounded annually, find the present value of P10,500 due at the
end of 6 years and 2 months.

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 Given:
F = P10,500; 1= 5%; m = 1
t = 6 years and 2 months.
whole period is 7 years minus 10 months. (7-10)
Solution:
t = 5% /1 n=7x1
= 5% =7

Step I P = F(1 + i)-ⁿ

P. = P10,500 (1 + 5%)-⁷
= P10,500 (.710681)
= 7,462.15
Step II
I= P, X r X t
= P7,462.15 x .05 x 10/12
= P310.92
Step III P, = P, +I
P, = 17,462.15 x P310.92
= P7,773.07

 Summary of the Approximate Method

A. Approximate Accumulation

Find the amount due at the end of the last whole period contained the given time, apply F=P
(1 +i)
2. Compute the simple interest on the result of step I for the remaining time at the given interest
rate, apply I = F x r x t
3. Add the results of steps I and II for the final answer, apply F, = F, +1
B. Approximate Discounting

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1. Discounting the amount F for the smallest number of whole periods containing the given
time, apply P, = F (1 + i)
2. Compute the simple interest on the result of step I for the excess time at the given interest
rate, apply I = P, XXL
3. Add the results of steps I and II for the final answer, apply P2 = P, +1

Lesson 8. Finding the Time by Linear Interpolation

(Capitulo et al. 1990)

Time refers to the term of an investment or how long it will take a certain sum of money
to amount to a certain other sum if it is invested at a certain interest rate. The linear
interpolation method is used to find the time when the interest rate is compounded. When
interpolating, it is sufficient to use four decimal places of the value in the table. The use of
more decimal places will not increase the accuracy of the result. The procedure of finding the
time will be illustrated by the following examples.

Illustrative Examples:
1. How long will it take P4,500 to amount to P6,100, if the interest rate is 5%
m = 4? P= P4,500; F=P6,100; r = 5%; m=4 n =? t =?
Solution:
i = 5%/4
= 1 1/4%
F = P(1 + i)"
6,100 = 14,500 (1 + 1 1/4%)"
(1 +1 1/4%)" =P6,100
P4,500
= 1,3556

Locate 1.3556 in table 2 under column i=11/4%. This value is located between two
consecutive values of n, 24 and 25, respectively, and construct a diagram like this:
n values
24 = 1.3474
1 d X = 1.3556 0.082 0.0168
25 = 1.3642

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 d = 0.082
1 0.0168
d = 0.4881
x = small i +d
= 24 + .4881
= 24.4881
t = x/m
= 24.4881/4
= 6.12 years

2. How long it will take for 7,350 to amount to 18,500, if invested at 8% m = 12?
Given:
P=27,350; F= P18,500; r= 8%; m = 12 n=?

Solution:
i = 8%/12 t=?
= 2/3%
F = P(1 + i)"
18,500 = 7,350 (1 + 2/3%)"
(1 + 2/3%)" = 18.500
7,350
= 2.5170
The value is located between n equals 138 and 139.
n values

138 = 2.5016
1 d X = 2.5170 0.0154 0.0167
139 = 2.5183
d = 0.0154
1 0.0167
d = 0.9222
x = small i + d
= 138 + 9222

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 = 138.9222
t = x/m
= 138.9222/12
= 11.58 years.

Lesson 9. Finding the Rate by Linear Interpolation

(Capitulo et al. 1990)

We have shown how to determine the time by using linear interpolation and finding the
amount and present value at compound interest using different methods. When the amount,
present value, and the time are given, but the interest or periodic rate cannot be exactly
located in the table we resort to linear interpolation.

The procedure will be illustrated by the following examples:

Illustrative Examples:
1. If 3,050 accumulates to 8,600 in 5 years, what is the rate compounded monthly?
Given:
P= P3,050; F=P8,660; t = 5 yrs; m = 12
Solution:
n= 5 x 12
=60 i=?
F=P(1 + i)"
18,660 = 23,050 (1 + i)60
(1 + i) 60 = P8,660
P3,050
= 2.8393

Locate 2.8393 in table 2 row 50 and look for two consecutive rates whose are near 2.8393.
The rates are 1 3/4% and 2% respectively, and construct a diagram like this:

n values
1 ¾% = 2.8318

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 1 d X = 2.8393 0.0075 0.4492
2% = 3.2810
d = 0.0075
¼% 0.4492
d = 0.0042%
x = small i + d
= 1.75% + 0.0042%
= 1.7542%
t = x/m
= 1.7542 x 12
= 21.05%

2. Find the rate compounded quarterly if 7745 accumulates to786 in 3 years and 9 months.
Given:
P=745; F=786; t=1-3 yrs. & 9 mos.: m=4
Solution:
n= 3 9/12 x 4
= 15
F = P(1 + i)
1786 =4745 (1 + i)ⁿ
(1 + i)¹⁵ = 786
745
= 1.0550

The value is located between i equals 1/3% & 5/12%

n values
1/3% = 1.0512
1 d X = 1.0550 0.0038 0.0132
5/12% = 1.0644
d = 0.0038
1/12 0.0132
d = 0.0240%
x = small i + d

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 = 0.3333% + 0.0240%
= 0.3573%
t = x/m
= 0.3573 x 4
= 1.43

Lesson 10. Nominal and Effective Rates

(Capitulo et al. 1990)

In compound interest problems there are three kinds of rates associated with them, name:
1. Periodic rate i. It is the rate used to compute compound interest factors, and it is equal to
interest rate r divided by the conversion period m.
2. When the conversion period is other than a year, the stated annual rate of interest is called
nominal rate J.
3. When the conversion period is one year, the annual rate of interest is called effective rate
e, the rate actually earned in a year.

 Nominal Rate J
In any investment problem, if the rate is not specified as nominal or effective, it is
assumed the given rate is nominal. To determine the nominal rate J, if the effective rate is
given, we apply this formula:

J=m [(1 + e)¹⁄ᵐ - 1] Table 4

where:
J = nominal rate
m= the conversion period per year. e = effective rate

Let us work on the following to illustrate the application of the above.

1. What nominal rate compounded monthly, will yield the effective rate of 3 ½%.
Given:
m = 12
e = 3 1/2%;
Solution:

87
 J = m [(1 + e) ¹⁄ᵐ - 1] Table 4
J = 12 [(1 + 3 1/2%)12 – 1]
= 12 [1.002871 - 1]
= 12 [.002871]
= .0345
= 3.45%
2. If interest is compounded quarterly, find the nominal rate if the effective rate is 10%
Given:
e = 10%; m=4
Solution:
J = m ((1 + e)¹⁄ᵐ- 1]
J = 4 [(1 + 10%) - 1)
= 4 (1.024114 - 1]
= 4 [.024114]
= .0965
= 9.65%

 Effective Rate e (Capitulo, F.M. et al. 1990)

To determine the effective rate e when the nominal rate J is given, we apply this
formula which was derived from the compound interest formula:
e = [(1 + J/m)ᵐ - 1) Table 2
where:
e = effective rate
J = nominal rate
m = conversion period per year.

When interest is compounded annually, the effective rate is equal to the nominal rate J,
but when it is compounded more than once a year, the effective rate is higher than the nominal
rate.
When comparing two different rates compounded at different conversion periods per year
m, we compute their respective effective rates.

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 Let us work on the following examples to illustrate the application of the above.

Illustrative Examples:

1. Find the effective rate corresponding to the rate 5 1/2% compounded quarterly.
Given:
J = 51/%; m= 4
Solution:
e = [(1 + J/m)-1] Table 2
e = [(1 + 5 1/2%/4)⁴ - 1]
= [(1 + 1 3/8%)⁴-1]
= [ 1.056145-1]
= .0561
= 5.61%

2. When interest is compounded monthly, find the effective rate corresponding to the nominal
rate 3 1/2%.
Given: J= 3 1/2%; m = 12
Solution
= [(1 + J/m)ᵐ - 1]
e = [(1 + 3 1/2% /12)12 1]
= [(1+ 7/24%)12- 1]
= [1.035567-1]
= .0356
= 3.56%

 Equivalent Rates (Capitulo et al. 1990)

If two rates, produce equal interests on the same period of time they are said to be
corresponding or equivalent rates.
Thus, 4 1/2%, m = 4 is equivalent to 4.48%, m= 12, and 6%, equivalent to 8.07%
simple interest in 9 3/4 years. (See solution below)

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 To determine the compound interest rate equivalent to another compound interest
rate, we apply this formula.
eq =me [(1 + g/m)ᵐ/ᵐᵉ – 1] Table 2 or 4

where:
г = the missing or unknown simple interest rate.
me= the periodic rate
t = the term or time of the investment
G=the given interest rate
m= the conversion period of the given rate.
r = [(1 + i)ⁿ– 1]
t
where:
r= the missing or unknown simple interest rate
i= the periodic rate
t= the term of the investment
n= the total number of conversion periods for the whole term

Let us work on the following examples to illustrate the application of the above.

Illustrative examples:
1. What rate compounded semiannually is equivalent to 5% compound monthly?
Given:
G = 5%, m= 12 m = 12 eg = ? me=2
Solution:
eg = me [(1 +G/m)ᵐ/ᵐᵉ-1]
= 2 [(1 + 5/12%)122 – 1]
= 2 ( 1 + 5/12%) – 1]
= 2 (1.025262-1) Table 2
= 2 [.025262]
= .050524
= 5.05%

90
2. What rate converted monthly is equivalent to 4 1/2% converted quarterly?
Given:
G =41/2%, m=4 eg= ? me= 12
Solution:
eg = me [(1+ G/m) ᵐ/ᵐᵉ -1]
= 12 [(1+ 4 1/2% 4)⁴/¹² 1]
= 12 [(1+ 1 1/8%)-1]
= 12 [1.03736-1] Table 4
= 12 [.003736]
= .044832
=4.48%
Note: The following pointers may be of help to the students on what table to apply:
a. When the exponent or total number of conversion periods for the whole investment
term n is a positive whole number, refer to table 2 for the corresponding value.
b. When the exponent is a negative whole number, use Table 3
c. When the exponent is a fraction expressible as 1/P, use Table 4
d. When the exponent is a mixed number, such as, 8 1/6, use Tables 2 and 4.

Assessment Task 5

1. Accumulate 5,300 for 5 years and 9 months at 5 ½% compounded quarterly

2. Find the compound amount and interest on 6,100 for 4 years and 3 months at 6%
compounded quarterly

3. What sum of money will be required to settle an obligation of 10,500 on April 1, 1992
if the loan is made on October 1, 1986 at a rate of 7% compounded quarterly

4. Accumulate 1,200 for 26 years and 3 months at 5 ½% compounded quarterly

91
5. Find the compound amount and interest on 720 for 40 years and 6 months at 4 ½%
compounded quarterly

6. Find the value of the following, if the present value is 1,100 at 9% converted annually
for 58 years

7. Accumulate 2,800 at 6% compounded quarterly for 7 years and 5 months

8. Find the compound amount and interest on 5,500 at 4% compounded semi-annually

for 8 years and 8 months

9. On August 1, 1990 Mr. Talamos borrows 9,500 and agrees to pay the compound
amount on the day he pays the debt. If interest is at the rate of 5 ½% compounded
quarterly, how much must Mr. Talamos pay to discharge his obligation on January 1,
2001

10. Discount 8,200 for 5 years and 5 months at 5% compounded monthly.

11. Find the present value of 11,600 due at the end of 7 years and 6 months if money is
worth 4 ½% converted semi-annually

12. If money is worth 3 ½% compounded monthly, find the compound discount if 12,200
is discounted for 2 years and 11 months

13. Discount 18,600 due at the end of 28 years and 4 months at 9% compounded monthly

14. Find the present value of 12,000 due at the end of 60 years at 10% compounded
annually

15. Find the present value of the following if the compound amount is 10,500 at 10%
converted annually for 65 years.

92
 Summary

 The present value is defined as the principal P which, if invested for the given time at
a given interest rate r, will amount to F on the date than F is due.

 This method is applicable when the interest rate or periodic rate is in the table
but the value of n is beyond the table limit.

 When interest is compounded annually, the effective rate is equal to the nominal rate
J, but when it is compounded more than once a year, the effective rate is higher than
the nominal rate.

 When comparing two different rates compounded at different conversion periods per
year m, we compute their respective effective rates.

 In any investment problem, if the rate is not specified as nominal or effective,

it is assumed the given rate is nominal.

Reference

Capitulo, Florante & Cruz, Carmelita (1990) Mathematics of Investment 2nd Edition.
Manila, Philippines National Bookstore Inc.

93
 MODULE 6
SIMPLE ANNUITIES

Introduction

Annuity is a series of periodic payments (usually equal) made at regular intervals of time.
Installment payments, monthly rentals, and life-insurance. The period of time between
consecutive payments is called the payment interval (pi). Term of an annuity is the time from
the beginning of the first payment interval to the end of the last payment interval. The interval
may be of any convenient length like monthly (m=12), quarterly (m=4), semiannually
premiums are familiar examples of annuities.

94
 Learning Outcomes

At the end of the chapter, students should be able to:

1. Enumerate types of annuities

2. Explain the significance of computing the annuity.

3. Compute periodic payment of an ordinary annuity, interest rate of an annuity

and terms of an annuity

Lesson 1. Types of Annuities (Capitulo et al. 1990)

A. Annuity Certain is an annuity payable for a definite duration not dependent on some
outside contingency. It means that this annuity begins and ends on a definite or fixed date.
Thus, monthly payment on a car form an annuity certain because the payments start on a
fixed date and continue until the required number of payments has been made.
B. Annuity Uncertain or Contingent Annuity is an annuity payable for an indefinite
duration in which the beginning or termination is dependent on some certain event. It means
that this annuity's first or last payment, or both, depends upon some events. Thus, pensions,
and life insurance policies are examples of annuity uncertain.

Kinds of Annuity Certain

I. Simple Annuity an annuity whose interest conversion or the same as the

payment interval (pi). [m = pil]

lI. General Annuity an annuity whose interest conversion period (m) is unequal or
not the same as the payment interval (pi) [m ≠ pi]

In this module, we shall be concerned with simple annuity where the dates of the first
and the last payments are known, and the interest conversion periods coincide with the
payment interval.

95
Classification of Simple Annuity

 Ordinary Annuity (Ao) is an annuity in which the periodic made at the end of each
payment interval.

 Annuity Due (A-due) is an annuity in which the periodic made at the beginning of each
payment interval.

 Deferred Annuity (A-def.) is an annuity in which the periodic payment is not made at
the beginning nor at the end of each payment interval but some later date.

The following notations will be used extensively throughout the discussion of annuities.

S= Sum or amount of an annuity.

A= present value of an annuity.
Rs= periodic payment of the sum.
Ra= periodic payment of the present value.
t= term of an annuity.
r= rate of an annuity.
n= number of conversion periods for the whole term (t x m)
m= number of conversion period per year.
I = interest per conversion period (r/m)
Ao= Ordinary Annuity
A (due) = Annuity Due
A (def) = Deferred Annuity

Ordinary Annuity - Amount and Present Value

The amount of an annuity is the total of all the periodic payments at the end of the
term, while the present value of an annuity is the total of the present value of all the payments
of the annuity.

96
 To determine the amount and present value of an ordinary annuity we apply the
following formulas:

S = Rs Table 5
n i
A =Ra Table 6
n i
(This is read as 'R angle n at i") or the alternative formulas:
S= R (1 +i)ⁿ-1 Table 2
i
A= R (1 +i)⁻ⁿ-1 Table 3
i
Let us work on the following examples to illustrate the application of the above.

Illustrative Examples:

1. Find the amount and present value of P150 payable every three months for 8 years and 6
months. If money is worth 5%, m = 4.
Given:
R=P150; r= 5%; m= 4; t = 8 yrs. & 6 mos.
Solution:
i= 5% n = 86/12 x 4
= 1 1/4% = 34
S = Rs Table 5
n i
S =150s
34 1 ¼%
= 150(42.045303)
= 6,306.79

97
A =Ra Table 6
n i
A =150a
34 1 ¼%
= 150 (27.560456)
= 4,134.07
Alternative Solution
S= R (1 +i)ⁿ-1 Table 2
i
= 150 (1 +1 ¼%)³⁴-1
1 ¼%
= 150 (1.525566-1
1 ¼%
= 6,306.79

A= R (1 +i)⁻ⁿ-1 Table 3
i
= 150 (1 +1 ¼%)⁻³⁴-1
1 ¼%
= 150[ (1-.655494)/.0125]
= 150 (27.560480)
= 4,13407

Periodic Payment of an Ordinary Annuity

Usually in business the amount or present value of an annuity is known and the
periodic payment (R) is to be determined. In this text the periodic payment (R) may be
computed by the following formulas.

Rs = S ____1____ Table 7
s
n i

98
Ra = A ____1____ +i Table 7
s
n i

or the alternative formulas

Rs = ____S____ Table 5
s
n i

Ra = ____A____ Table 6
a
n i

Let us work on the following examples to illustrate the application of the above.

Illustrative Examples:

1. How much monthly deposit must be made for 8 years and 6 months in order to accumulate
P12,500 at 7% compounded monthly?
Given:
S =P12,500; r = 7%; m= 12; t = 8 yrs. & 6 mos.

n=86/12 x 12 i = 7%/ 12
= 102 = 7/12%

Rs = S ____1____ Table 7
s
n i

Rs =12,500 ____1____ Table 7

99
 s
102 7/12%
=12,500 (0.0072303)
= 90.04

Alternative Solution:
Rs = ____S____ Table 5
s
n i
Rs = ____12,500____
s
102 7/12%
= 12,500
138.839909
= 90.03
*rounding error

2. What sum will be paid at the end of every three months for 9 years and months, if the
present value is P15.000 and interest is paid at 6% compounded quarterly?
Given:
A = P15,000; r =6%; m= 4; t = 9 yrs. & 9 mos.
Solution:
i = 6%/4 n=99/12 x 4
= 1 1/2% = 39
Ra = A ____1____ +i Table 7
s
n i

=15,000 ____1____ +1 ½% Table 7

s
39 1 ½%
= 15,000 (0.19055 +.015)
= 15,000(.034055)

100
 =510.82
Altemative Solution:
Ra = ____A____ Table 6
a
n i
Ra = ____15,000____ Table 6
a
39 1 ½%
= 15,000
29.364583
= 510.82

Lesson 2. Finding the Interest Rate of an Annuity

(Capitulo et al. 1990)

In some problems the amount or present value, periodic payments and the number of
payments is given. If the interest rate is to be determined, we use linear interpolation. The
manner of interpolating the rate was discussed in 2.9
Let us work on the following examples to show how this is being done

Illustrative Examples

1. Find the interest rate compounded quarterly at which payments of 80 every three months
will amount to P3,750 in 7 years and 3 months.
Given:
Rs = P80, S = P3,750; t = 7 yrs. & 3 mos.; m =4
Solution:
S = Rs Table 6
n i
3,750 = 80 s
29 i
s = 3,750
29 i 80
= 46.8750

101
 We refer to table 5 and go across the row of n = 29 until we or two successive values
where this value is located and record the values as follows:

3% = 45.2188
½% d x = 46.8750 1.6562 3.6920
3 ½% = 48.9108

d = 1.6562 х = small i + d
½% 3.6920 = 3.0 +2.441
= 1.6562 x1 = 3.2441%
3.6920 2
= .2441% r =Xxm
= 3.2441% x 4
= 12.98%

2. An item can be bought for P5,000 or for P500 down payment and 195 a month for 24
months. Find the rate compounded monthly.
Given:
Cash Price =P5,000; Dp = P500; Ra= P195; t = 24 mos
Solution:
A = P5,000-P500
= P4,500 n= 24

Substitute in the present value of Ao formula.

A = Ra Table 6
n i
P4,500 = P195 a
24 i
a = P4,500
24 i 195
= 23.0769

102
 We refer to table 6 and go across the row of n = 24 until we find 23.0769 or two
successive values where this value is located, and record as follows:

7/24% = 23.1467
1/24% d x = 23.0769 0.0698 0.1184
1/3% = 23.0283

d = 0.698 х = small i + d
1/24% 0.1184 = 0.2917% +0.0246
= 0.698 x1 = 0.3163%
0.1184 24
= .0246% r =Xxm
= 0.3163% x 12
= 3.80%

Lesson 3. Finding the Term of an Annuity

(Capitulo et al. 1990)

When the number of payments is not exactly equivalent to the original amount or
present value, there are various procedures in finding the term of an annuity. In this book, we
shall use the procedures where the small payments or concluding payment (c.p) can be made
one period after the last regular payment. But sometimes the concluding payment is not
required because the interest after the last regular payment is equal to or more than the
balance needed.

To illustrate this procedure, let us work on the following examples.

Illustrative Examples:

1. Find the time and the number of semiannual payments of P480 each and the concluding
payment which must be made to accumulate P18,500, if money earns interest at 7%
compounded semiannually.
Given:

103
 Rs = P480; S = P18,500; r= 7%; m=2
Solution:
i = 7%/2 i= 3 1/2%

Substitute in the amount form

S = Rs Table 5
n i
18,500 = 480s
n 3 ½%
s = 18,500
n 3 ½% 480
= 38.541667

Now we look at table 5 under column 3 1/2% for the factor 38.541667. The factor is located
between n is 24 and 25. Il means, that there are 24 regular payments and a smaller payment
on the 25th. To determine the value of the smaller or concluding payment we follow the
procedures summarized below.
Procedures in finding the concluding payment in S problem

Step I Determine the amount one period after the last regular payment by the use of
S = Rs -1 Table 5
n i

Step II Subtract the result of I from the original amount to get the concluding payment
Solution
S = Rs -1 Table 5
n i
= 480 s -1
25 3 1/2$%
= 480(38.949857)
= 18,215.93

Step II Cp = P18,500 - P18,215.93

104
 = P284.07
Therefore:
24 semiannual payments plus c.p. of P284.07 or 12 years plus c.p. of P284.07

2. Ogan borrows P20,000 with interest at 5 1/2% compounded quarterly. He agrees to pay
P850 at the end of each three months. How long must he pay? What is the size of the
concluding payment?
Given A = P20,000; Ra = P850; i= 1.3/8% m=4

Solution:
i = 5 ½%/4 = 1 3/8%

Substitute in the present value formula.

A = Ra Table 6
n i
200,000 = 850a
n 1 3/8%
= 23.529412

Locate 23.529412 in table 6 under column 1 3/8% and this factor is low between the values
of n is 28 and 29. It means, that there are 28 regular payments and a concluding payment on
the 29th period. To determine the valued concluding payment, we follow the procedures
summarized below.
Step I Determine the amount one period after the last regular payment by
S = Rs -1 Table 5
n i
Step II Accumulate the present value one period after the last regular payment by the
use of:
F= P(1 + i)" Table 2

Step III Subtract the result of I from the result of II to get the concluding payment.
Solution:
Step I

105
 S = Rs -1 Table 5
n i
= 850 s -1
29 1 3/8%
= 850 (35.339567 -1)
= 850 (34.33957)
= 29,188.63
Step II
F = P (1+i)ⁿ Table 2
= 20,000 (1+1 3/8%)²⁹
= 20,000(1.485919)
= 29,718.38
Step III
C.p = II – I
= 29,718.38 – 29,188.63
= 529.75
Therefore: 7 years plus c.p. of P529.75 or 28 regular payments plus c.p of 529.75

 Things to Remember:

1. Ordinary Annuity (Ao) is an annuity in which the periodic payment (R) is made at the end
of each payment interval.

2. Annuity Due (A-due) is an annuity in which the periodic payment (R) is made at the
beginning of each payment interval.

Assessment task 6

1. Find the amount and present value of an annuity of 440 payable every three months
for 15 years and 3 months, if money is worth 5 ½% m=4

106
2. Find the cash value of a sala set that can be bought for 2,500 down payment and 288
a month for 36 months if money is worth 3 ½% compounded semi-annually

3. A fund is to created by investing 900 at the end of every month for 9 years. IF money
is worth 9% compounded monthly, how much is in the fund at the end of the term?

4. If money is worth 5% compounded quarterly, how much must Cristina save every end
of three months to have 20,000 at the end of 15 years?

5. How much must be paid every end of 6 months for 14 years to liquidate an obligation
of 25,400 if money is worth 5 ½% compounded semi-annually

6. How much must be paid for 48 months to settle an obligation of 13,800 if money is
worth 3% converted monthly

7. Find the interest rate compounded quarterly on 9,500 whose periodic deposit is 300
every end of three months for 6 years and 9 months

8. If 55 periodic payments per year for 18 years amount to 7,885 what is the annual rate?

9. An item can be purchased for 4,500 or for 1,500 down payment and installment
payment of 115 every six months for 15 years. Find the interest rate compounded
semi-annually

10. The present value of an annuity is 16,950. Quarterly payments of 369 are made from
16,950 that is invested at 4% compounded quarterly. How many regular payments will
be made and what is the size of the concluding payment?

11. A man deposits 320 at the end of each three months in an account paying 6%
converted quarterly. In order to accumulate 9,400, how many regular deposits every
three months must he make and what is the size of the concluding payments if one is
needed?

107
12. An item is for sale for 7,800, Mr. Bing can pay 2,200 down payment and 240 every
end of the month. IF he gets the loan at 7% compounded monthly, how many regular
payments of 240 must he make and what will be the size of the concluding payment

13. Find the amount and present value of an annuity due of 125 every quarter for 9 years
and 6 months, if money is worth 5% converted quarterly

Summary

 Annuity Certain is an annuity payable for a definite duration not dependent on some
outside contingency. It means that this annuity begins and ends on a definite or fixed
date. Thus, monthly payment on a car form an annuity certain because the payments
start on a fixed date and continue until the required number of payments has been
made.

 Annuity Uncertain or Contingent Annuity is an annuity payable for an indefinite

duration in which the beginning or termination is dependent on some certain event. It
means that this annuity's first or last payment, or both, depends upon some events.
Thus, pensions, and life insurance policies are examples of annuity uncertain.

 Ordinary Annuity (Ao) is an annuity in which the periodic made at the end of each
payment interval.

 Annuity Due (A-due) is an annuity in which the periodic made at the beginning of each
payment interval.

108
 Deferred Annuity (A-def.) is an annuity in which the periodic payment is not made at
the beginning nor at the end of each payment interval but some later date.

 Usually in business the amount or present value of an annuity is known and the
periodic payment (R) is to be determined

 The amount of an annuity is the total of all the periodic payments at the end of
the term, while the present value of an annuity is the total of the present value
of all the payments of the annuity.

 Ordinary Annuity (Ao) is an annuity in which the periodic payment (R) is made
at the end of each payment interval.

 Annuity Due (A-due) is an annuity in which the periodic payment (R) is made
at the beginning of each payment interval.

Reference

Capitulo, Florante & Cruz, Carmelita (1990) Mathematics of Investment 2nd Edition.
Manila, Philippines National Bookstore Inc.

109
 MODULE 7
AMORTIZATION AND SINKING FUND

Introduction

Amortization is the gradual extinguishment of any amount over a period of time, that
is, the extinction of a debt, principal and interest by means of a sequence of equal periodic
payments or installment payments due at the end of equal intervals of time. Usually, the equal
payments form an annuity.

Sinking fund is a savings fund, productively invested, into which equal periodic
payments are made. It is designed to accumulate a specific sum of money within a specified
date. A sinking fund is created with a definite end in view, such as big expenses in the future.

Learning Outcomes

110
 At the end of this module, students should be able to:

1. Define amortization and sinking fund

2. Prepare amortization schedule

3. Compute for the outstanding principal using two methods

4. Apply the concepts learned by answering all the assessment tasks.

Lesson 1. Amortization of a Debt (Capitulo et al. 1990)

When a debt is amortized by equal payments at equal intervals, the debt becomes the
present value of an ordinary annuity (Ao); hence, we apply the formula of an ordinary annuity.

For the present value:

A = Ra Table 6
n i

For the periodic payment:

Ra = A Ra =A 1+i
a s
n i n i
Table 6 Table 7

 Amortization Schedule is a table which shows how much is applied to reduce the
principal and how much portion is paid for interest to show the outstanding principal
or remaining liabilities after each payment period. In this module , we shall discuss
amortization schedules with regular periodic payments.

111
 Let us work on the following examples to illustrate the above.

Illustrative Examples:

1. A loan of P4000 is to be amortized by equal payments at the end of quarter for 1 year and
6 months. If interest is 5% compounded quarterly, find the periodic payment and construct an
amortization schedule.

Given:
A = P4,000; r = 5%, m=4 t= 1 yr. & 6 mos.

Solution:
i = 5%/4 n=16/12 x 4
=114% =6

Ra = A Table 6
a
n i
= 4,000
a
6 1 ¼%
= 696.14

Amortization Schedule
Payment # Principal Repaid Interest Paid Periodic Payment Unpaid Balance
1 646.14 50.00 696.14 4,000
2 654.22 41.92 696.14 3,353.86
3 662.39 33.75 696.14 2,699.64
4 670.69 25.47 696.14 2,037.25
5 679.06 17.08 696.14 1,366.58
6 687.55 8.59 696.14 687.52
4,000.00 176.81 4,176.84

Note:

112
 1. As to be expected, the interest paid decreases each payment (since the debt is getting
smaller), and the payment towards reduction of the obligation increases
correspondingly,

2. The total principal is equal to the original loan, if in case of more or less P.05 difference
repeat the process.

3. A loan of 6 semi-annual payments of 450 are to be made to pay for a loan at 5 1/2%
compounded semi-annually. Find the value of the loan and construct an amortization schedule
Given: R=P450 r=5 1/2%, m = 2 n= 6
Solution:
i= 5 1/2%/2 i= 23/4%
6 i
A = Ra Table 6
n i

A = 450a Table 6
6 2 ¾%
= P450 (5.462367)
= P2,458.07

Amortization Schedule
Payment # Principal Repaid Interest Paid Periodic Payment Unpaid Balance
1 382.40 67.60 450 2,458.07
2 392.92 57.08 450 2,075.67
3 403.72 46.28 450 1,682.75
4 414.83 35.17 450 1,279.03
5 426.23 23.77 450 864.20
6 437.96 12.04 450 437.97
2,458.06 241.94 2,700.00

Lesson 2. Finding the Outstanding Principal

(Capitulo et al. 1990)

113
 Both the borrower and the lender must be updated on the status of any obligation, that
is, they should know the remaining liabilities or outstanding principal O.P. before or after any
given number of payments.

In the preceding lesson, we will illustrate the amortization schedule showing the
outstanding principal, the break-down of the periodic payment into interest and principal
repaid after given payment. However, when the number of payments is too large, constructing
an amortization schedule becomes laborious and tedious. Hence, short-cut methods are
adopted. We shall consider two methods in determining the outstanding principal O.P. or
remaining liability, namely:

a. Prospective Method
b. Retrospective Method
 Prospective Method

This method uses the future history of the debt. With this much remaining liability or
outstanding principal is equivalent to the present value of all payments which must remain to
be made. When all the payments including the last one are the same, it is usually simpler to
apply this formula:
OP = Ra Table 6
n-k i
where:
OP = Outstanding principal
R = periodic payment
i = periodic rate
n = total number of payments
k = number of past payments
n-k = number of future payments that remains to be made.
Let us work on the following examples to illustrate the application above.

Illustrative Examples:

114
1.A loan is to be amortized by equal payments of P500 each at the end of each six months
for 10 years. If the interest is based on 7% compounded semi-annually, find:

a. the present value of the loan.

b. outstanding principal just after the 8th payment
c. the remaining liability after 8 years.
Given: R = 2500; r = 7%; m = 2 t = 10 yrs.
Solution:
i = 7%/2 n = 10 x2
i = 3 1/2% n = 20

a. A = Ra Table 6
n i

A = 500a Table 6
20 3 1/2%
A = 500 (14.212403)
= P7,106.20
b. n = 20 k=8 n-k = 20-8 = 12
OP = Ra Table 6
n-k i

OP₁₂ = 500a Table 6

20-8 3 ½%
= 500 (9.663334)
= 4,831.67
c. n = 20 k=8x2= 16 n-k = 20 – 16 = 4
OP = Ra Table 6
n-k i
OP₄ = 500a Table 6
20-16 3 ½%
= 500 (3.673079)
= 1,836.54

115
  Retrospective Method

This method uses the past history of the debt. With this method, the outstanding principal
is equivalent to the difference between the accumulated value of the loan and the accumulated
value of the past payments. When all the periodic payments, excluding the last one, are the
same, it is appropriate to use this method by applying this formula:

OP = (Accum. value of A-Accum. value of past payments) or

OP = A (a + i)^k - Rs
Table 2 k i Table 5
where:
OP = outstanding principal
А = present value of the loan
R = periodic payment
i= periodic rate
k= number of past payments

Let us work on the following examples to illustrate the above.

Illustrative Examples:

1. A loan ofP6,000, with interest at 6% converted quarterly is to be amortized by payments of

P200 of the end of each three months for as long as necessary. Find:
a. the outstanding principal at the end of 4 years.
b. the remaining liability just after the 30th payment
c. the final or concluding payment

Given: A = P6,000; R = P200; r=6%; m=4

Solution:
i= 6%/4
i= 1 1/2%
a. k= 4 x 4 k= 16

116
 OP = A (1 + i)^k -Rs
k i
OP = 6,000 (1 +1 1/2%)¹⁶- 200 S
16 1 ½%
OP = 6,000 (1.268986) - 200 (17.932370)
= 7,613.92 - 3,586.47
= 4,027.45
b. k=30
OP = A (1 + i)^k -Rs
k i
OP = 6,000 (1 +1 1/2%)³⁰- 200s
30 1 ½%
= 6,000 (1.563080) – 200(37.538681)
= 9,378.48 – 7,507.74
= 1,870.74
c. The final payment
Step 1. Determine the last regular payment of the loan by dividing A by R and locate
the value in table 6 with the corresponding n at the interest rate per period (i)
A =R a
n i
6,000 = 200 a
n 1 ½%

a = 6,000
n 1 ½% 200
=30

The corresponding n in Table 6 of 30 is between 40 and 41. This means, that the last
regular payment will be on the 40th, and the final payment on the 41st payment.

Step 2 Determine the outstanding principal just after the last regular payment of R.
K = 40
OP = A (1 + i)^k -Rs

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 k i
=6,000 (1+1 ½%)⁴⁰- 200s
40 1 ½%

= P6,000 (1.814018) - P200 (54.267894)

=P10,884.11 - P10,853.58
= P30.53

Step 3 Solve for the interest by multiplying the OP by the periodic rate.
I= OP xi
I = P30.53 x .015
= P.46
Step 4 Solve for the final payment (Fp) by adding OP + 1.
Fp = OP + 1
Fp = P30.53 +.46
= P30.99

 Procedures In Finding The Final Payment

1. Determine the last regular payment by dividing A by R using formula

A = Ra Table 6
n i

2. Determine the outstanding principal just after the last regular payment of R by applying
formula:
OP = A (1 + i)^k - Rs
k i

3. Determine the interest by multiplying OP by the periodic rate.

I = OP x i
4. Determine the final payment by adding the results of 2 & 3.
Fp = OP + I

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Lesson 3. Sinking Fund (Capitulo et al. 1990)

Sinking Fund is a savings fund productively invested in anticipation for future

expenses. The amount in the fund at any given period is the total of the periodic deposits
already made including the interest earned.

A sinking fund schedule is a table showing the gradual growth of more deposited to
create a fund. It also shows how much interest is earned every period, and the amount before
and after the periodic deposits.

To create a sinking fund, we should know the periodic payment or deposit and the sum
to be raised. We apply the formula of an ordinary annuity.

S =Rs Table 5
n i
R = S or R= S 1
s s
n i n i
Table 5 Table 7

Let us work on the following examples to illustrate the above.

Illustrative Examples:

1. The sum of P3,500 will be needed at the end of 3 years. If money can be invested at 5%
compounded semiannually, find:
a. the periodic payment;
b. construct a sinking fund schedule.

Given: S = P3,500; r= 5%; m= 2; t = 3 years

Solution:

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 i = 5%/2 n =3x2
= 2 ½% =6
a. Periodic Rate (R)
R = S or R =S 1
s s
n i n i
R = 3,500 = 3,500 1
s s
6 2 ½% 6 2 ½%
= 3,500 = 3,500(0.156550)
6.387737 = 547.92
= 547.92

 Sinking Fund Schedule

Number of Periodic Deposit Interest in Fund Increased in Fund Amount in Fund

Payment
1 547.92 0.00 547.92 547.92
2 547.92 13.70 561.62 1,109.54
3 547.92 27.74 575.66 1,685.20
4 547.92 42.13 590.05 2,275.25
5 547.92 56.88 604.80 2,880.05
6 547.92 72.00 619.92 3,499.97

Sometimes the final amount is lesser or greater by a few centavos than what it should be, due
to rounding errors.

Assessment task 7

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 1. A debt of P3,500 is to be amortized by 6 equal semiannual payments with interest at
6%compounded semiannually. Find the periodic payment and construct on
amortization schedule.

2. Monthly payments of P800 each are used to settle a loan for 8 months at 8%
compounded monthly. Find the present value of the loan and construct an amortization
table.

3. A sala set costs P6,800 cash. A buyer pays P2,500 down-payment and the balance will
be paid by equal monthly installment payments for 8 months with interest rate of 6%
compounded monthly. Find:
a. the monthly payments:
b. construct an amortization schedule.

4. An obligation will be amortized by quarterly payments of P670 for 10 years. If interest is at

6% compounded quarterly, find:
a. the present value of the loan;
b. the outstanding principal after 7 years; the remaining liability just after the 30th payment;
d. how much of the 20th payment is interest, and how much goes to principal?

5. A debt of P56,000, with interest at 5% compounded monthly, will be discharged, interest

included, by monthly payments of P500 for as long as necessary, Find:
a. the number of regular payments;
b. the outstanding principal after 4 years;
c. the final or concluding payment.

6. A man purchases a car for P65,000 and pays P20,000 down payment. The balance, with
interest at 5 1/2% compounded semiannually, will be amortized for the next 4 years. Find:
a. the semiannual payment
b. the remaining debt at the end of 3 years;
c. the OP just after the 5th payment.

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7. How much must a man place in a fund at the end of each month in order to have P12,500
at the end of 4 years, if money is worth 7% compound monthly? Construct a sinking fund
table for 6 months.

8. Construct a sinking fund table showing the growth of the fund over 5 years, if P950 is to
be deposited at a rate of 6% compounded semi-annually.

9. How much must be deposited in a fund at the end of each six months for 12 years to raise
P25,000 by the end of that time, if money is worth 5% compounded semiannually? Make
out the first six lines of the sinking

Summary

 When a debt is amortized by equal payments at equal intervals, the debt

becomes the present value of an ordinary annuity (Ao); hence, we apply the
formula of an ordinary annuity.

 Sinking fund is a savings fund, productively invested, into which equal periodic
payments are made. It is designed to accumulate a specific sum of money
within a specified date. A sinking fund is created with a definite end in view,
such as big expenses in the future.

 Amortization Schedule is a table which shows how much is applied to

reduce the principal and how much portion is paid for interest to show
the outstanding principal or remaining liabilities after each payment
period.

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  Retrospective Method is the method used in computing the interest rate
based from the past history of the debt. With this method, the
outstanding principal is equivalent to the difference between the
accumulated value of the loan and the accumulated value of the past
payments

 Prospective Method is the method used in computing the interest rate

based from the future history of the debt. With this much remaining
liability or outstanding principal is equivalent to the present value of all
payments which must remain to be made.

 Sinking Fund is a savings fund productively invested in anticipation for

future expenses. The amount in the fund at any given period is the total
of the periodic deposits already made including the interest earned.
Reference

Capitulo, Florante & Cruz, Carmelita (1990) Mathematics of Investment 2nd Edition.
Manila, Philippines National Bookstore Inc.

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