CHAPTER 6 - SIMPLE AND COMBUND INTEREST. Definition of Terms Lender or creditor - person (or institution) who invests the money or makes the funds available Borrower or debtor - person (or institution) who owes the money or avails of the funds fromthe lender Origin or loan date - date on which money is received by the borrower ‘Repayment date or maturity date - a date on which the money borrowed or loan is to be completely repaid ‘Time or term (1) - amount of time in years the money is borrowed or invested; length of time between the origin and maturity dates, Principal (P) - amount of money borrowed or invested on the origin date Rate (r) - annual rate, usually in percent, charged by the lender, or rate of increase of the investment Interest (1) - amount paid or earned for the use of money ‘Simple Interest (Is) - interest that is computed on the principal and then added to it 0. Compound Interest (Ic) - interest is computed on the principal and also on the accumulated past interests 11, Maturity value or future value (F) - amount after t years; that the lender receives from the borrower on the maturity date ween He eens Formula of Annual Simple Interest Is=Prt where Is= simple interest principal ate = term or time, in years EXAMPLE 1. A bank offers 0.25% annual simple interest rate for a particular deposit. How much interest will be earned if 1 million pesos is deposited in this savings account for 1 year? Solution: Given: P= 1,000, 000 r= 0,25% = 0.0025 year Find: Is = Prt = (1, 000, 000)(0.0025)(1) = 2, 500 Answer: ‘The interest earned is P2,500. EXAMPLE 2, How much interest is charged when P50,000 Is borrowed for 9 months at an annual simple interest rate of 10%? Solutior gi Given: P=50,000 r= 10% =0.10 t=9/12year = 0.75 year Find: Is Note: When the term is expressed in months (M), it should be converted to years by t=M/12, Is = Prt = (50, 000)(0.10)(0.75) = 3, 750 Answer: The simple interest charged is P3,750. EXAMPLE 3. Complete the table below by finding the unknown [Principal (P) Rate (r) Time (t) Interest @ 25% 4 1,500 36,000 (b) 15 4860 250,000 0.5% © 275, 500,000 125% 10 (@) Solutions: (a) The unknown principal can be obtained by (b) The unknown rate can be computed by r =Is/Pt = 4, 860/(36, 000)(1.5) = 0.09 = 9% (c) The unknown time can be calculated by t =Is/Pr = 275/(250,000)(0.005)= 0.22 years (qd) The unknown simple interest is given by Is = Prt = (500, 000)(0.125)(10) = 625,000 EXAMPLE 4, When invested at an annual interest rate-of 7%, an amount earned P11,200 of simple interest in two years. How much money was originally invested? Solution, Given: % = 0.07 years 15= 11,200 Find: is/tt = 11, 200/(0.07)(2) = 80, 000 Anbwer: ‘The amount invested is P80,000. y EXAMPLE 5. If an entrepreneur applies for a loan amounting to P500,00' 157,500 for 3 years, what interest rate is being charged? a bank, the simple interest of whict Solution. Given; P= 500,000 Is = 157, 500 3 years Find: r=Is/Pt = 157, 500/(500, 000)(3) = 0.105 = 10.5% Answer: ‘The bank charged an annual simple interest rate of 10.5%.EXAMPLE 6. How long will a principal earn an interest equal to half of it at 5% simple interest? Solution. Given: Po r=5%=0.05 Is=%P=0.5P Find: t=1s/Pr=0.5P/(P)(0.05) = 10 years Answer: It will take 10 years for a principal to earn half of its value at 5% simple annual interest rate , Formula: Maturity (Future) Value F=P4ls where F = maturity (future) value P incipal imple interest Substituting Isby Prt gives F F=P(1+rt) Maturity (Future) Value where F = maturity (future) value rincipal interest rerm / time in years EXAMPLE 7. Find the maturity value if 1 million pesos is deposited in a bank at an annual simple interest rate of 0.25% after (a) 1 year and(b) 5 years? Solution. Given: P= 1,000, 000 1 = 0.25% = 0.0025 Find: (a) maturity or future value F after 1 year (b) maturity or future value F after 5 years Note: There are two ways to solve the problem. Method 1: Solve the simple interest Is first and then add it to P, thatis, Method 2: Use the derived formula F = P(1 + rt). a. When t= 1, the simple interest is given by Method 1: + Is=Prt=(1, 000, 000)(0.0025)(1) = 2, 500 ‘The maturity or future value is given by F =P + Is= 1, 000, 000 + 2, 500 = 1, 002, 500 Method 2; To directly solve the future value F, F=P(1 + rt) = (1, 000, 000)(1 + 0,0025(1)) = 1, 002, 500 Answer: The future or maturity value after 1 year is P1, 002, 500. be Whent= Method 1 Prt = (1, 000, 000)(0.0025)(5) = 12, 500 + Is= 1, 000, 000 + 12, 500 = 1, 012, 500 Method 2: (1+ rt) = (1, 000, 000)(1 + 0.0025(5)) = 1, 012, 500 Answer; ‘The future or maturity value after 5 years is P1, 012, 500. Exercises: 1. Find the unknown principal P, rate r, time t, and interest [ by completing the table. Principal (P) Rate (r) Time (0) Interest 10,000 8% 15 (@) (o) 2% 5 10,000 : 360,000 © 2 3,600 ‘500,000 70.5% = @ 175,500 880,000 9.25% 25 © 2, Whatare the amounts of interest and maturity value ofa loan for P150, 000 at 6 ¥ simple interest for 3 years? ; At what simple interest rate per annum will P25, 000 accumulate to P33, 000 in 5 years? How long will P40, 000 amount to P51, 200 ifthe simple interest rate is at 12% per annum? In order to have P200, 000 in 3 years, how much should you invest if the simple interest is 5.597 ‘Angel deposited P20, 000 in a bank that pays 0.5% simpie interest. How much will be her money after 6 years? aneFormula: Maturity (Future) Value and Compound Interest F=P(1+rjt Where: P = principal or present value F = maturity (future) value at the end of the term interest rate t= term / time in years Compound Interest + The compound interest (Ie) is given by [ex F-P EXAMPLE 1. Find the maturity value and the compound interest if P10,000 is compounded annually at an interest rate of 2% in 5 years. Solution. Given: P=10,000 r=2%=0.02 t=5 years Find: (a) maturity value F (b) compound interest lc (@) F=P(1+1)'= (10, 000)(1 + 0.02)5= 11, 040.081 (b) Ie= F-P = 11, 04.81 - 10, 000 = 1,040.81 Answer: ‘The future value F is P11,040.81 and the compound interest is P1,040.81 EXAMPLE 2. Find the maturity value and interest if P50,000 is invested at 5% compounded annually for 8 years. Solution, Given: P=50,000 r=5%=0.05 t=8 years Fin (a) maturity value F (©) compound interest le (@) F= P(1 + r)t= (50, 000)(1 + 0.05)8 = 73, 872.77 (b) le= F - P=73, 872.77 - 50, 000 = 23, 872.77 Answer: The maturity value F ts P73,872.77 and the compound interest is P23,872.77. EXAMPLE 3. Suppose your father deposited in your bank account P10,000 at an annual interest rate of 0.5% compounded yearly when you graduate from kindergarten and did not get the amount until you finish Grade 12, How much will you have in your bank account after 12 years? Solution. Given: P=10,000 r=05%=0.005 t= 12 years Find: F. The future value F is calculated by F=P(1 +1) (10, 000)(1 + 0.005)!2= 10, 616.78 Answer: ‘The amount will become P10,616.77 after 12 years. Formula for Present Value P at Compound Interest PoF/(1+r)t= FO +ryt Where P= principal or present value F = maturity (future) value at the end of the term interest rate = term / time in years EXAMPLE 4, What is the present value of P50,000 due in 7 years if money is worth 10% compounded annually? Solution. Given: = 50,000 r=10%=0.1 =7 years Find: P. The present value P can be obtained by P=F/(1+r)'= 50, 000/(1 + 0.1)? = 25, 657.91 Answer: ‘The present value is P25,657.91. EXAMPLE 5. How much money should a student place in a time deposit in a bank that pays 1.1% compounded annually so that he will have P200,000 after 6 years? Solution. Given: F=200,000 r=1.1%=0.011 t= 6years Find: P. The present value P can be obtained by , =F/(1 + 1)'= 200, 000/(1 + 0,011)6= 187, 293.65, Answer: The student should deposit P187,293.65 in the bank. Exercises: ; 1.__Find the unknown principal P, rate r, time t, and compound interest Ie by completing the table. Principal (P) Rate (r) Time (1) Compound Interest | Maturity Value (F) 10,000 8% _ 15 @ o) 3,000 5% 6 ©. @) 50,000 10.5% 10 @ O: @ 2% 5 (h) 50,000 [ oO 9.25% 25 oO 100,000Compounding More than Once a Year Definition of Terms 1. conversion or interest period - time between successive conversions of interest 2. frequency of conversion {m) - number of conversion periods in one year 3. nominal rate ({(™)) - annual rate of interest 4 rate_{) of interest for each conversion period 3 j= ilm)/m = annual rate of interest/frequency of conversion 5. totalnumber ofconversion periodsn m= tm = (frequency of conversion) x (time in years) 7 Nom 7 = fe = Nominal Rate mmi= Frequency of | j= Interest Rate par 5 (Annual interest Rate) Conversions conversion period Soe rere 2% compounded annua 1 coat =002=2% | tyear egies 19 aa 2 0.0272 = 0.01 = 1% 6 months ee compguced aera 4 0.024 = 0.005 = 0.5% 3 months Pi compgunded wont 12 0.02112 = 0.0016 = 0.16% 4 month a 365 0.02/365 1 day Formula for Maturity Value, Compounding m times a year F = P (1+ Where = nominal rate of interest (annual rate) m= frequency of conversion t= term / time in years EXAMPLE 1. Find the maturity value and interest if P10,000 is deposited in a bank at 2% compounded quarterly for Syears. | Solution. Giver P= 10,000 i=0.02 t=Syears = m=4 Fins @F () P Compute for the interest rate in a conversion period by Compute for the total number of conversion periods given by n 0 periods Compute for the maturity value using F = P(1 +f} 1,048.96 Answer: The compound interests given by le= F- P= 11, 048.96 - 10, 000 = P1, 048.96, EXAMPLE 2. Find the maturity value and interest if P10,000 is deposited in a bank at 296 compounded monthly for 5 years. Solution, Given: P= 10,000 102-002 t=Syears — m=12 Find: (a) F (b) P Compute for the interest rate in a conversion period by j= ((2)/m = 0.02/1 Compute for the total number of conversion periods given by n = mt = (12)(5) Compute for the maturity value using F = P(1 +j)*= (10, 000)(1 + 0.0016)60= P11, 050.79 Answer: The compound interest is given by le=F - P= 11, 050.79 - 10, 000 P1, 050.79 EXAMPLE 3. Cris borrows P50,000 and promises to pay the principal and interest at 12% compounded monthly. How much must he repay after 6 years? Solution. . Given: P= P50, 000 @%=012 t=6 © m=12 game 012) (12) Find: F=P(1+5)" =50,000 (+2 = 50,000(1.01)7? = 102,354.97 Answer: ‘Thus, Cris must pay P102,354.97 after 6 years. EXERCISES: Complete the table by computing for compound amounts, compound interests and present values. Tincipal | “'gate | compounded | Conversion | perperiod | in Years | ofconversions | interest | Amount 10,000 | 8% poem @ ) 15 © @ © 3,000 | 5% | quarterly o @ eee @ o 0 | 12% | montniy 0 (m) 10 ) @ | 50000